Fed adopts a new strategy that opens the door for higher inflation. The change is fundamentally positive for gold prices.
Fed adopts a new strategy that opens the door for higher inflation. The change is fundamentally positive for gold prices.
So, it happened! In line with market expectations, the Fed has changed its monetary policy framework into a more dovish one! This is something we warned our Readers in our last Fundamental Gold Report:
the Fed could change how it defines and achieves its inflation goal, trying, for example, to achieve its inflation target as an average over a longer time period rather than on an annual basis.
And it turned out that our worries were justified. On Thursday, the FOMC announced the approval of updates to its Statement on Longer-Run Goals and Monetary Policy Strategy. The change was timed for Fed Chairman Jerome Powell’s speech to the Jackson Hole economic symposium.
Generally speaking, the Fed declared that it will focus more on the job market and won’t worry about higher inflation. This is because “a robust job market can be sustained without causing an unwelcome increase in inflation”, as Powell explained in his remarks discussing the policy shift.
Being more specific, the most significant changes to the framework document are:
It’s a great change (at least in rhetoric, as we doubt whether the Fed ever worried about inflation since Volcker left the U.S. central bank), as it means de facto adopting price-level targeting. Undershoots of inflation are not forgotten, but they are made up for later. Of course, we are yet to see whether the Fed will manage to trigger higher official inflation rates (as successfully as asset price inflation), but shift allows the Fed to ease its monetary policy even further and to implement its dovish bias even stronger!
What does it all mean for the gold market? Well, the updated Fed’s strategy opens the door for easier monetary policy, ultra low interest rates for longer, and higher inflation. So, the shift is fundamentally positive for the gold prices. Actually, it could be the trigger that gold needed to continue its rally further north. However, the initial gold’s reaction has been negative (i.e., after a spike, there was a sharp reversal), as the chart below shows.
Of course, investors should remember that the updated strategy does not mean that we will see double-digit inflation tomorrow. The inflation has been under the Fed’s target for years, so it does not have to rise just because the Fed changed its monetary framework. And the FOMC wrote about inflation “moderately” above the target – yeah, we know that they couldn’t write otherwise, but we really doubt whether the Fed officials really want to see double-digit inflation rates.
However, as we have repeated many times, the current economic crisis is more inflationary that the Great Recession. The recent fast increase in the broad money supply increases the risk of higher inflation in the future. Now, the Fed’s announcement that it will welcome and embrace the rise in inflation, should increase inflation expectations, increasing the demand for gold as an inflation-hedge. Higher inflation expectations would also lower the real interest rates, also supporting the gold prices. Thank you, Mr. Powell!
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Arkadiusz Sieron, PhD
Sunshine Profits: Analysis. Care. Profits.
Arkadiusz Sieroń, Ph.D., is an Assistant Professor at University of Wrocław. He is a certified Investment Adviser and a long-time precious metals market enthusiast.