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Gold Driver: Federal Reserve Throwing in Towel on Inflation?

Isaac Nuriani    |
Mar 29, 2024
  • Federal Reserve still expects three rate cuts in 2024 in spite of continued inflation.
  • Strategists project gold moving deeper into record territory on falling real yields.
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Now hanging around all-time highs above $2,200 per ounce, gold continues to demonstrate significant strength a month into its latest surge.[1]

Analysts cite varied reasons for the global support of gold prices these days, including (1) heightened geopolitical tension, (2) America’s deteriorating fiscal stability and (3) the drive among numerous central banks to diversify their reserves away from the dollar.[2]

And yes…also fueling gold right now, say analysts, is the growing prospect that lower interest rates finally may be here sooner rather than later.

“Wait a minute…lower interest rates?” some of you might be asking. “Why would central banks lower interest rates? Isn’t inflation still a problem?”

It is, indeed.

The higher inflation that first began in April 2021, when the consumer price index (CPI) initially poked its head above the Federal Reserve’s 2% target level, remains with us today, nearly three years later.[3]

To be clear, after reaching a peak annual rate of 9.1% in June 2022, inflation has been on the way back down ever since. But the closer to earth it travels, the longer the journey seems to take.[4]

Economists refer to inflation that seems to get more persistent the more it declines as “sticky.” And it seems that despite the “stickiness” of inflation right now, the Federal Reserve could be on the verge of loosening interest rates.

Altering course and deciding to end the explicit fight against inflation before that foe has been clearly vanquished is a pretty big deal actually. That’s because doing so could imply that the Fed is abandoning the longstanding, carved-in-stone 2% target and telegraphing a willingness to accept higher inflation as a part of the currently evolving economic environment.

Previously, the Fed suggested that defeating inflation is the most urgent matter at hand.[5] But there are suggestions the central bank may have concluded that it’s pressing its luck by keeping rates in such relatively restrictive territory for so long…and that the most prudent course of action, all things considered, is to begin loosening, even as inflation remains above target.

We’re going to talk about this in some depth this week. And we’re going to do so not simply in the context of central bank policy, but also in terms of what it could mean for precious metals. Because while declining rates, in general, tend to be good news for precious metals, lowering interest rates even as higher inflation persists can be particularly good news.

Let’s talk about all of it.

March Madness? In Spite of Persistent Inflation, Policymakers Say to Look for Three Rate Cuts in 2024

If the central bank abandons what has been its single-minded focus on getting inflation back to 2%, it won’t be for lack of trying to get the job done.

Whatever criticisms can be lodged fairly at the central bank for waiting too long to attack price pressures initially, the Fed’s resolve in fighting inflation – once it decided to fight inflation – can’t be questioned.

For example: From March 2022 to July 2023, the Fed raised interest rates by 525 basis points.[6] That’s the fastest pace of rate increases in 40 years.[7]

It appeared Fed policymakers were making progress. Against the backdrop of stringent rate hikes, headline CPI fell from 9.1% in June 2022 all the way down to 3.0% a year later.[8] The return to the 2% target level was practically at hand, it seemed.

Except it wasn’t – and it isn’t. Since all-items CPI dropped to 3.0% in June 2023, that metric not only hasn’t fallen any further, it has remained above 3.0% every month since, averaging more than 3.3% from July 2023 through February 2024.[9]

The news has been largely the same with respect to core inflation, which excludes volatile food and energy prices and is therefore considered to be a more accurate reflection of underlying economic inflation.

Last December, core CPI finally drifted below 4% for the first time in 31 months, coming in at 3.9%. But its rate of decline has been at a snail’s pace since: As of last month, core had dropped only as far as 3.8%…still nearly twice the Fed’s official target.[10]

And so as recent inflation numbers have continued running hot, expectations were growing that the Federal Reserve might decide to formally back away from earlier projections of three rate cuts in 2024.[11]

That’s not what happened. Although Fed officials kept rates in the 5.25 to 5.50 range at their policy meeting earlier this month, the updated Summary of Economic Projections (SEP) – which reflects where Fed officials think key data such as GDP, inflation and interest rates are headed – again indicates three quarter-point rate cuts by the end of 2024.[12]

Given inflation’s persistence, that updated SEP might be viewed as a momentous declaration on the part of the Fed…because it implies the central bank could be willing to cut interest rates before inflation is back to target.

Comments made by Fed Chair Jerome Powell at the post-policy-meeting press conference seem to underscore this notion. We’re going to break those down next, as well as look at why one of the world’s most respected economists thinks that what the Fed did and what the chairman had to say could be a sign the central bank actually might be stepping away from adherence to a formal inflation target.

Powell: “Appropriate to Dial Back Policy Restraint This Year”

Whitney Watson, co-head and co-chief investment officer of Fixed Income and Liquidity Solutions at Goldman Sachs Asset Management, had a message for clients shortly after the conclusion of the Fed’s policy meeting last week.

“Despite projections of stronger growth, lower unemployment, and slightly higher core PCE inflation,” Watson wrote, “policymakers still anticipate three rate cuts this year.”[13]

Concerns had started to grow that central bankers might dial back those expectations as signs persisted of both continued inflation and a tight labor market.[14]

But the updated SEP seemed to allay those fears…as did remarks made by Fed Chair Jay Powell at the conclusion of the policy meeting.

“We believe that our policy rate is likely at its peak for this type of cycle, and that if the economy evolves broadly as expected, it will likely be appropriate to begin dialing back policy restraint at some point this year,” Powell said at one point.[15]

Referring to the hotter-than-expected inflation data in January and February, Powell seemed surprisingly sanguine, considering his historical tendency to downplay any signs of improvement in inflation.[16]

Powell said those inflation figures “haven’t really changed the overall story, which is that of inflation moving down gradually on a sometimes-bumpy road towards 2%.”[17]

Underscoring what certainly sounded to be a more relaxed posture on the effort to get inflation back to target, Powell at one point said, “We’re strongly committed to bringing inflation down to 2% over time. But we stress, over time.”[18]

The relative lack of urgency implied by that statement seems a far cry from the chairman’s outlook in August 2022, expressed during his keynote address at the Jackson Hole Economic Symposium.

“The historical record cautions strongly against prematurely loosening policy,” Powell said at the time. “We must keep at it until the job is done.”[19]

Notable, too, was the chairman’s remarks about winding down quantitative tightening (QT), a mechanism by which the Fed reduces excess liquidity from the financial system by allowing the bonds it purchased during quantitative easing to reach maturity without replacing them. Through that process, the Fed has reduced the size of its balance sheet by about $1.4 trillion since the COVID-related peak of April 2022.[20]

But in another tip of the hat to the growing prospect of a pivot to easier-money policy, Powell strongly hinted that the time for QT could be drawing to a close.

“While we did not make any decisions today, the general sense of the committee is that it will be appropriate to slow the pace of runoff fairly soon, consistent with the plans we previously issued,” the chairman said.[21]

Some observers seem genuinely surprised at just how dovish the central bank’s posture now seems to be. Among them is the renowned economist Mohamed El-Erian, who thinks that dovishness may telegraph a sea change in how the Fed now is looking at inflation targets.

Economist El-Erian: Fed May Have Formally “Stepped Away from Strict Inflation Target”

During an appearance last week on CNBC’s Squawk Box, El-Erian related his interpretation of the posture assumed by Fed policymakers this month, saying it effectively sends “a signal that they’re willing to tolerate higher inflation for longer.”[22]

El-Erian referred to the Fed’s apparent tolerance of both higher inflation and a higher balance sheet as “twin patience,” saying:

“I think that twin patience means that we may well look back on this week as the week in which central banks stepped away from a very strict inflation target to a much broader concept of an inflation target.”[23]

In the economist’s view, the Fed is shifting its view in this way for two distinct reasons. Referring to policymakers, he said:

“I think they realize two things: The economy is weakening, and that we are living in a world in which the supply side is the problem [behind inflation].”[24]

The significance is that supply-side catalysts of higher prices – such as supply-chain issues, inflexibility in the labor market and the increased costs associated with the green-energy transition – cannot be as readily influenced by monetary policy as demand catalysts.

The other reason the Fed seems ready to back away from its use of policy to continue battling inflation, in El-Erian’s view, is the perception that the economy could be slowing down.

“The Fed realizes the economy is weakening,” El-Erian said, pointing to signs of fragility in manufacturing and employment data.[25]

Ultimately, says Mohamed El-Erian, “The Fed will have a choice: It accepts slightly higher inflation, or it unnecessarily tips the economy into recession” by keeping monetary policy in restrictive territory.[26]

And in his view, the central bank has chosen to accept higher inflation.

The implications of that could be significant for precious metals. Let’s talk about that as we close out this week’s article.

J.P. Morgan: Rate Cuts and Falling Real Yields “Will Be Mono-Driver Behind Gold’s Rally”

There are a number of meaningful implications associated with reducing interest rates even as higher inflation continues. One is the possibility that cutting rates this way could reignite the very price pressures the central bank has worked so hard to contain.

But another, more pleasant potential implication is the beneficial impact that such a move could have on precious metals.

As noted at the outset of this piece, gold appears to be benefiting from several structural drivers right now, according to analysts. But those same analysts also put at or near the top of their list of primary gold-price catalysts the reduction of interest rates in an environment where inflation remains an issue.

That’s because cutting rates during periods of elevated inflation reduces real, or inflation-adjusted, yields. Inflation always eats into whatever is earned in nominal terms from an interest-bearing vehicle. But when rates start coming down, the degree to which inflation consumes profits becomes greater. And if rates fall below the rate of inflation, that means real yields have turned negative.

Gold has a history of thriving in this kind of monetary environment. Lower real yields tend to mean dollar weakness – typically a reliable gold driver – as well as a lower “opportunity cost” of holding non-interest-paying bullion; also good for gold.

One of the many investment banks that see gold potentially benefiting this year from lower rates and real yields is J.P. Morgan.

“Gold’s inverse relationship to real yields has historically been weaker over Fed hiking cycles, before strengthening again as yields fall over a transition into a cutting cycle,” Gregory Shearer, head of base and precious metals strategy at J.P. Morgan, said in January.[27]

Referencing the expected impact to yields throughout the rest of the year based on projected rate cuts, Shearer added, “We think over this period, the Fed cutting cycle and falling U.S. real yields will once again become the mono-driver behind gold’s breakout rally later in 2024.”[28] At the time, Shearer said he expected gold to reach $2,300 later this year.

The price target of $2,300 per ounce is also what analysts at another global banking behemoth, Goldman Sachs, have in mind for gold before the year is out. They, too, see declining real rates as a key to realizing that price.

The most recent Fed meeting “reinforced the market’s (and ours) expectations that three cuts are likely this year, lending renewed support to gold to test and surpass March’s earlier record high,” wrote the Goldman analysts.[29]

J.P. Morgan Managing Director Says Gold Is Firm’s Number One Commodities Markets Pick

And in a more recent price projection from J.P. Morgan than the one offered up by strategist Gregory Shearer, Natasha Kaneva, managing director at Morgan, said her team sees gold rising as high as $2,500 per ounce this year largely on the metals-favorable climate that would be created by anticipated rate cuts.[30]

Kaneva said at the same time that gold now is J.P. Morgan’s number one pick in commodities markets this year.[31]

It seems a little odd to be considering that the Federal Reserve actually might throw in the towel on fighting price pressures – particularly in light of the central bank’s longstanding position that it would do whatever it takes to get inflation back to target (2%).

But here we are. All things considered, perhaps it is the most prudent path in terms of the well-being of the economy, as Mohamed El-Erian suggests. We’ll have to wait and see, assuming policymakers do begin cutting rates while inflation remains elevated.

As for the potential impact of such a policy move on gold, analysts seem confident it will be a benefit – perhaps a substantial one, as J.P. Morgan’s Natasha Kaneva suggests.

That, too, is a matter of “wait and see.” Investors who think gold’s fundamental properties make it an appropriate consideration for their own portfolios might feel even more positive about the metal based on the projected path of monetary policy through at least the near term. Some who are retirement investors, specifically, might even see fit to acquire gold – or silver – through a gold IRA, if they feel duly inspired.

Those are personal decisions, ultimately. What happens next with monetary policy isn’t a personal decision. But it has the potential to affect just about everyone directly. And for savvy consumers and savers who understand the potential implications of prospective policy changes, now may be the time to start preparing for the possibility of what the nation’s mighty central bank could do next.

[1] CNBC.com, “Gold COMEX (Jun′24)” (accessed 3/28/24).
[2] Marcus Ashworth, Bloomberg.com, “Gold’s Record-Setting Pace Is Exuberantly Rational” (March 14, 2024, accessed 3/28/24).
[3] U.S. Inflation Calculator, “Historical Inflation Rates: 1914-2024” (accessed 3/28/24).
[4] Ibid.
[5] Ann Saphir and Lindsay Dunsmuir, Reuters.com, “Fed vows unconditional inflation war with ‘whatever it takes’” (June 17, 2022, accessed 3/28/24).
[6] FederalReserve.gov, “Open Market Operations” (accessed 3/28/24).
[7] Preston Caldwell, Morningstar.com, “When Will the Fed Start Cutting Interest Rates?” (March 1, 2024, accessed 3/28/24).
[8] U.S. Inflation Calculator, “Historical Inflation Rates.”
[9] Ibid.
[10] U.S. Inflation Calculator, “United States Core Inflation Rates (1957-2024)” (accessed 3/28/24).
[11] FederalReserve.gov, “Summary of Economic Projections” (December 13, 2023, accessed 3/28/24).
[12] NewYorkFed.org, “Summary of Economic Projections” (March 20, 2024, accessed 3/28/24).
[13] Bryan Mena et al., CNN.com, “Stocks surge after Fed indicates three rate cuts still coming this year” (March 20, 2024, accessed 3/28/24).
[14] Ibid.
[15] Jeff Cox, CNBC.com, “Fed holds rates steady and maintains three cuts coming sometime this year” (March 20, 2024, accessed 3/28/24).
[16] Christopher Rugaber, AP News, “Fed’s Powell notes inflation is easing but downplays discussion of interest rate cuts” (December 1, 2023, accessed 3/28/24).
[17] Christopher Rugaber, AP News, “Federal Reserve still foresees 3 interest rate cuts this year despite bump in inflation” (March 20, 2024, accessed 3/28/24).
[18] Rich Miller, Bloomberg.com, “Fed’s Powell Ready to Support Job Market, Even If It Means Lingering Inflation” (March 24, 2024, accessed 3/28/24).
[19] Howard Schneider and Ann Saphir, Reuters.com, “Powell sees pain ahead as Fed sticks to the fast lane to beat inflation” (August 26, 2022, accessed 3/28/24).
[20] Michael Derby, Reuters.com, “Fed’s Powell says balance sheet drawdown taper coming soon” (March 20, 2024, accessed 3/28/24); Brian Scheid, S&P Global, “Fed eyes slowing balance sheet runoff as liquidity concerns emerge” (January 22, 2024, accessed 3/28/24).
[21] Cox, “Fed holds rates steady.”
[22] CNBC.com, “This week may be the week central banks stepped away from strict inflation targets: Mohamed El-Erian” (March 21, 2024, accessed 3/28/24).
[23] Ibid.
[24] Ibid.
[25] CNBC.com, “This week may be the week”; Institute for Supply Management, “Manufacturing PMI® at 47.8%; February 2024 Manufacturing ISM® Report On Business®” (March 1, 2024, accessed 3/28/24); Austen Hufford, Wall Street Journal, “Job Quitting Fell 12% Last Year—and That’s Bad News for the Economy” (January 30, 2024, accessed 3/28/24).
[26] CNBC.com, “This week may be the week.”
[27] J.P. Morgan, “Will gold prices hit another all-time high in 2024?” (January 17, 2024, accessed 3/28/24).
[28] Ibid.
[29] Ines Ferre, Yahoo Finance, “Gold’s ‘record march higher set to continue,’ Goldman says” (March 25, 2024, accessed 3/28/24).
[30] Yvonne Yue Li and Tope Alake, Bloomberg.com, “Gold Is JPMorgan’s Top Pick in Commodities With Price Eyeing $2,500” (March 13, 2024, accessed 3/28/24).
[31] Ibid.

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