Minutes From November 2017 FOMC Meeting And Gold

Last week, the minutes of the FOMC November meeting were released. What do they say about the Fed’s stance and what do they mean for the gold market?

Fed Hike Is Coming

On Wednesday, the minutes of the latest FOMC meeting were published. How can we summarize them? As earlier this year, the FOMC members agreed that the labor market had continued to strengthen. Actually, they believed that there was full employment in the U.S.:

“Many participants judged that the economy was operating at or above full employment and anticipated that the labor market would tighten somewhat further in the near term, as GDP was expected to grow at a pace exceeding that of potential output.”

The Committee was also optimistic about economic growth, as it upgraded its assessment of the GDP. The FOMC noted that “economic activity had been rising at a solid rate despite hurricane-related disruptions.” Last time, the economic growth was described as moderate.

Low Inflation: Temporary Or Persistent?

The most interesting discussion among the FOMC members was about the subdued inflation. The consensus is still that the lack of inflationary pressure results from temporary or idiosyncratic factors which will wane over time. In other words, the inflation rate will eventually reach the 2-percent target over the medium term:

“Many participants judged that much of the recent softness in core inflation reflected temporary or idiosyncratic factors and that inflation would begin to rise once the influence of these factors began to wane. Most participants continued to think that the cyclical pressures associated with a tightening labor market were likely to show through to higher inflation over the medium term.”

However, the FOMC members started to accept the view that inflation might remain below the target longer than expected due to the death of the Phillips curve or higher slack in the labor market than previously thought:

“With core inflation readings continuing to surprise on the downside, however, many participants observed that there was some likelihood that inflation might remain below 2 percent for longer than they currently expected, and they discussed possible reasons for the recent shortfall. Several participants pointed to a diminished responsiveness of inflation to resource utilization, to the possibility that the degree of labor market tightness was less than currently estimated, or to lags in the response of inflation to greater resource utilization as plausible explanations for the continued soft readings on inflation.”

In other words, although the consensus among the FOMC members is still that the subdued inflation results from cyclical factors, an alternate view is emerging. According to it, the low inflation may be caused by more permanent factors:

“Many participants observed, however, that continued low readings on inflation, which had occurred even as the labor market tightened, might reflect not only transitory factors, but also the influence of developments that could prove more persistent. A number of these participants were worried that a decline in longer-term inflation expectations would make it more challenging for the Committee to promote a return of inflation to 2 percent over the medium term”.

Targeting Inflation Rate Or Price Level?

Some FOMC members were so worried about the low readings on inflation that they discussed the possibility of changing the monetary regime from inflation targeting to, for example, price level targeting:

“In view of the persistent shortfall of inflation from the Committee's 2 percent objective and questions about whether longer-term inflation expectations were consistent with achievement of that objective, a couple of participants discussed the possibility that potential alternative frameworks for the conduct of monetary policy could be helpful in fulfilling the Committee's statutory mandate. One question, for example, was whether a framework that generally sought to keep the price level close to a gradually rising path--rather than the current approach in which the Committee does not seek to make up for past deviations of inflation from the 2 percent goal--might be more effective in fostering the Committee's objectives if the neutral level of the federal funds rate remains low.”

As we explained in October 2016, price-level targeting is similar to inflation targeting, but under such a regime, the central banks’ target not the change in the price level (i.e., the rate of inflation), but the level of prices. The implication is that the central bank would try to offset past deviations from the target. It should be clear that an implementation of this regime could increase inflation in the current environment, spurring some inflation-hedge demand for gold.

Conclusions

The U.S. central bank published minutes from tts November meeting. They were not very surprising, as they basically showed that although the FOMC members were concerned about subdued inflation, the December hike was coming. The market odds of the Fed’s upward move in the last month of the year were little changed and they still amounted to 100 percent.

However, the growing concerns about low inflation and the subtle shift in the Fed’s tone may slow down the tightening cycle in 2018. The central bank previously signaled three rate hikes next year. Now, it seems that the FOMC members have second thoughts – it is clearly positive for the gold market. If the Fed turns out to be more dovish than expected, gold may shine. On the other hand, investors should remember that the composition of the FOMC is likely to shift to more hawkish in 2018, which is a headwind for the price of gold. Stay tuned!

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.

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