Gold Responds to Yellen’s Discussion of NIRP

Janet Yellen, the Chair of the Federal Reserve, testified yesterday to the Senate Committee on Banking, Housing, and Urban Affairs. Did she say something new? What do her remarks mean for the gold market?

Yellen on Negative Interest Rates

Since Yellen submitted identical reports to the Senate and the House of Representatives on Wednesday, we will focus on the question and answer session. She acknowledged the current risks for the economy, but downplayed the possibility of a recession in the U.S., reiterating that economic expansions “don’t die of old age”. However, other remarks sounded rather more dovish. Probably, the discussion on negative interest rates was the most important part. Yellen said:

“We had previously considered them and decided that they would not work well to foster accommodation back in 2010. In light of the experience of European countries and others that have gone to negative rates, we are taking a look at them again, because we would want to be prepared in the event that we needed to add accommodation. We haven’t finished that evaluation. We need to consider the U.S. institutional context and whether they would work well here. It’s not automatic. There are a number of things to consider. So I wouldn’t take those off the table, but we would have work to do to judge whether they would be workable”.

It means that NIRP is still on the table. It does not matter that negative interest rates did not work for Japan or the Eurozone. It does not matter that ZIRP did not work for the U.S. The central bankers fueled asset bubbles all over the world that are popping right now (rising yields on junk bonds in the energy sector are meaningful) and now they are helpless. The only answer they figured out is to further cut interest rates, even below zero.

Did the Fed Lose its Credibility?

Yellen’s discussion of the negative interest rates made the yellow metal to surge to above $1,260, the highest since February 2015. Actually, gold is one of the best assets this year. It is outperforming not only other commodities but also the S&P 500 and other financial assets. The shiny metal is benefiting from rising safe-haven buying. Yellen’s comments that the Fed is evaluating negative rates only added fuel to the fire. The message is clearly dovish, investors hear something like that: “The situation is so bad, that we are considering even such a crazy idea as NIRP. We are obviously out of ammunition and we have no idea what to do.”

Yellen’s remarks on the U.S. dollar’s appreciation and the decline in energy prices did not help to restore confidence in the Fed. She frankly admitted that the Fed had not anticipated the extent of the strengthening of the greenback and that it is hard to predict exactly when energy prices and the U.S. dollar stabilize. You don’t say? Everybody knows that predictions are very difficult, especially about the future, however, investors might not necessarily want to hear that the most important central bank in the world knows nothing. For us, this is a big problem with being data-dependent. Surely, it is very wise to be guided by data. However, it creates the impression that the Fed does not know where it is going. As Seneca pointed out, when a man does not know what harbor he is making for, no wind is the right wind.

Conclusions

Summing up, Yellen testified before the Senate. In the eyes of investors, her remarks were more dovish than testimony before the House of Representatives, especially that she did not rule out negative interest rates. Gold responded to her testimony by further rising. The reduced confidence in the Fed and the U.S. economy and the risk-off sentiment have made gold one of the best-performing assets in 2016 so far.