Powell told the Senate he didn’t want a recession. Who would be? However, it can happen either way, driving up gold prices.
“The economy is strong”
Last week, Powell testified before Congress. He reiterated many things he said at his recent press conference, but I believe there are a few points worth noting.
First, Powell reiterated that the Fed is strongly committed to fighting high inflation and that more rate hikes are coming. I wouldn’t be surprised to see the fed funds rate at or above 3% at the end of this year, which would make this cycle of tightening the fastest in decades.
However, the US central bank is so aggressive only because the labor market remains strong, but if the economy slows further and the unemployment rate starts to rise, the Fed will face a much tougher dilemma – and I doubt he will remain as bellicose as he is today. In fact, the reason for these sharp interest rate hikes could be that the Fed is aware of this and wants to tighten monetary policy as much as possible before the economy collapses. However, such large movements could only hasten the advent of unrest.
Second, Powell painted a surprisingly upbeat picture of the US economy, saying it “is very strong and well positioned to handle tighter monetary policy.” Well, I doubt it. The American economy is highly indebted and sharp increases could be hard to swallow for excessively indebted entities. Other writings on the wall include the yield curve inverting, the S&P 500 index entering the bear market, and credit spreads widening significantly, as seen in the chart below.
GDP growth is slowing. Indeed, the GDPNow model estimates that GDP growth (seasonally adjusted annual rate) will increase by 0.0% in the second quarter of 2022. On my planet, zero growth does not indicate a “very strong” economy, but stagnation. Now is the time for the rebus for Fed officials: stagnation plus inflation =? Yes, fine, stagflation. Stagflation, which indicates huge macroeconomic imbalances, means anything but a very strong economy.
It can still happen
Third, Powell downplayed the risk of recession. He admitted that was “certainly a possibility”, but not the outcome the central bank intended: “We are not trying to cause and do not think we will need to cause a recession.” Well, could he say anything else? Can you imagine the chairman of the Fed saying in front of Congress, “We have absolutely not responded in a timely manner to rising inflation and now we have to engineer a recession, or at least an economic downturn, to curb it. »? I can’t.
However, this is what it is with the Philips curve, still widely used by central banks. According to the Phillips curve, there is a trade-off between inflation and the unemployment rate, and you can only reduce inflation by increasing unemployment. Sure, the Phillips curve is woefully flawed, but that’s what central bankers believe in. So the Fed may not be trying to invoke a recession, but it is certainly trying to reduce aggregate demand and cool the overheated economy.
The objective of central bankers is to become modestly restrictive on growth, or, in other words, to stage a soft landing. The problem is that this is very difficult to achieve and recessionseven if this is not necessarily the expected result, are very often the unintended consequence of a tightening of monetary policy. Charles L. Evans, President of the Chicago Fed, was surprisingly honest about this:
We obviously take risks when we want to slow demand to keep it in line with supply. To say that we can hone something like that with incredible precision – I mean, we just don’t have that ability.
In effect, the last three cycles of Fed hikes have been followed by financial crises and economic downturns (dot-com crisis, the Great Recession, the pension crisis in 2019 and the coronavirus crisis in 2020), as shown in the graph below.
Implications for Gold
What does all this mean for the gold market? Well, the Fed is now really determined to rein in inflation. Therefore, precious metals investors should be prepared for further rate hikes in the coming months. This hawkish stance will continue to put downward pressure on gold prices in the near future.
However, in the long or even medium term, I am more bullish on gold. Indeed, GDP growth is slowing, which increases the risk of stagflation and the next economic crisis. Economic confidence is clearly collapsing, which should increase the demand for gold as a safe haven. At some point, the tightening cycle will be over and the Fed will be forced to return to its dovish stance, which should be welcomed by the yellow metal.
Disclaimer: The opinions expressed in this article are those of the author and may not reflect those of Kitco Metals Inc. The author has made every effort to ensure the accuracy of the information provided; however, neither Kitco Metals Inc. nor the author can guarantee such accuracy. This article is strictly for informational purposes only. This is not a solicitation to trade commodities, securities or other financial instruments. Kitco Metals Inc. and the author of this article accept no responsibility for loss and/or damage resulting from the use of this publication.