Hawkish Rate Cut Sends Gold Prices Down

Fed Cuts Interest Rates by 25 Basis Points

Yesterday, the FOMC published the monetary policy statement from its latest meeting that took place on July 30-31st. In line with expectations, the U.S. central bank cut its interest rates. It was the first interest rate cut since the Great Recession and just a few months since the last interest rate hike.

As we had expected, the Fed lowered the target of the federal funds rate not by half, but by a quarter of percentage point, from 2.25-2.50 to 2.00-2.25:

Consistent with its statutory mandate, the Committee seeks to foster maximum employment and price stability. In light of the implications of global developments for the economic outlook as well as muted inflation pressures, the Committee decided to lower the target range for the federal funds rate to 2 to 2-1/4 percent. This action supports the Committee’s view that sustained expansion of economic activity, strong labor market conditions, and inflation near the Committee’s symmetric 2 percent objective are the most likely outcomes, but uncertainties about this outlook remain.

Interestingly, the decision was again not unanimous, as Esther L. George and Eric S. Rosengren wanted to maintain the interest rates unchanged. It suggests that it might be difficult for doves among the FOMC to force further interest rates cuts. The hawkish commentary on economic conditions and labor conditions – “information received since the Federal Open Market Committee met in June indicates that the labor market remains strong and that economic activity has been rising at a moderate rate” – also suggests low inclination for another cut in coming months.

Additionally, the Fed announced that it will end its quantitative tightening in August, two months earlier than previously indicated. It means that the Fed’s balance sheet will be less reduced even less than earlier projected. We always knew that the Fed is not going to fully dial back its quantitative easing, but this is a gross mockery. At least, Trump liked the move: “as usual, Powell let us down, but at least he is ending quantitative tightening, which shouldn’t have started in the first place.”

Why, Mr. Powell?

Now, the natural question is why the heck did the Fed cut rates despite moderate GDP growth and the record low unemployment rate? Maybe the decision stems from caring about the state of the world economy, not the American economy? Perhaps Powell could not stand the pressure of the White House and the merciless tweets of Donald Trump? Or maybe the Fed knows something that we do not know? Maybe the state of the U.S. economy is not as good as it seems at first glance? Did the inversion of the yield curve frighten the central bankers?

Powell said in his opening statement at the press conference that the interest rate cut is

intended to insure against downside risks from weak global growth and trade policy uncertainty; to help offset the effects these factors are currently having on the economy; and to promote a faster return of inflation to our symmetric 2 percent objective

So it would be just an insurance cut. Indeed, Powell described the move as a “mid-cycle adjustment,” not as the “beginning of a lengthy cutting cycle”. Not good for gold.

Implications for Gold

We were right. On Tuesday’s Gold News Monitor, we wrote:

So, decline in the gold price is possible after the FOMC meeting, especially if the Fed reduces the federal funds rate by only 25 basis points (…) However, a lot will depend on the message accompanying the move. If Powell tries to persuade markets that the cut is just a one-off event, seeing gold reverse its recent gains will be in order

And this is exactly what happened. The Fed reduced interest rates, but it was a hawkish cut. We mean here that the Powell disappointed the markets by ruling out an aggressive monetary-easing campaign. It was a cold shower for the gold bulls. The price of gold declined from $1,430 yesterday to $1,405 today, as the chart below shows.

Chart 1: Gold prices from July 30 to August 1, 2019

Monetary policy-wise, the end of the tightening cycle would take away the downward pressure from the gold market. However, gold fundamentally needs an aggressive long rate-cutting cycle to rally. The gold bulls have to wait some more for it. The Fed is not laying (yet) the groundwork for additional cuts in the near future. But gold bulls should not be depressed: if the Fed cut interest rates by 25 basis points just as insurance to downside risks, just think what they will do when a real crisis arrives!

Disclaimer: Please note that the aim of the above analysis is to discuss the likely long-term impact of the featured phenomenon on the price of gold and this analysis does not indicate (nor does it aim to do so) whether gold is likely to move higher or lower in the short- or medium term. In order to determine the latter, many additional factors need to be considered (i.e. sentiment, chart patterns, cycles, indicators, ratios, self-similar patterns and more) and we are taking them into account (and discussing the short- and medium-term outlook) in our trading alerts.

Thank you.

Arkadiusz Sieron

Sunshine Profits‘ Gold News Monitor and Gold Market Overview Editor

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