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Gold Bulls Want this from Powell

By Ashraf Laidi  |  27/02/2018 11:08

You must have read several trading previews ahead of today’s Congressional testimony from the new head of the Federal Reserve Jay Powell. Most analysts/traders are looking for the following two items:

i) the extent to which Powell opens the door for the possibility of four interest rate hikes this year from the Federal Reserve Open Market Committee’s current view of three rate hikes;

ii) the extent of his support for Trump’s $1.5 trillion infrastructure, widely seen adding over $2 trillion to the national debt.

Worst Case Scenario for Stocks
The worst case scenario for stocks and bonds from Powell’s testimony would be staunch support for Trump’s reckless budget spending, while simultaneously opening the case for four interest rate hikes. Realistically, that is not a viable outcome as Powell is unlikely to depart from his usually gradualist rhetoric, especially in his first Congressional testimony as Fed chair. And with labour markets yet to provide more durable evidence of rising pay growth, it is of no use to rock the boat at this time.

Best Case Scenario for Gold
What about gold? What would be the most positive scenario for metals during Powell’s testimony to the House of Representative today and Senate tomorrow? Simply put: any indication that Powell is willing to show patience with inflation nearing and overshooting the Fed’s 2.0% target would be specifically positive for gold and silver and commodities in general.

Is it realistic?
It surely is. This week’s testimony may not be the suitable setting for Powell to expand on the intricacies of inflation dynamics but he could well set the stage for it into future appearances.

Growing reports within Fed circles (current and former FOMC members) are circulating that the Fed is willing to allow inflation to overshoot its 2.0% target from the current 1.7%, as long as it does not surpass 2.5%.

Reason for patience:
- Symmetry. The 2.0% inflation target is considered to be a symmetric target, reflecting the central bank’s willingness to allow price growth to deviate +(-) the central 2.0% target with an acceptable margin of +(-) 0.5%. So just as inflation stood below the 2.0% target for nearly six years, it can be allowed to hover near 2.5% for the next few years.

- Getting it right. Although headline CPI hit 2.1% y/y in January, core CPI (excluding food and energy) hovers around 1.8% y/y. More importantly, the Fed’s preferred inflation target –core personal consumption expenditure (core PCE) is at 1.5% y/y. Crucially, in each of the two occasions when core PCE reached or surpassed 2.0% (spring 2012 and autumn 2016), inflation had peaked, followed by a decline in growth or commodity prices, or both.

- Jobs & wages. Despite the 9-year high print in US average hourly earnings of 2.9% y/y in January, it remains to be seen whether labour markets have peaked out. The fact that non-farm payrolls have plateaued near 200,000 and the labour participation rate remains adrift near its 40-year low of 62.3%, may suggest that the advance in wages is an end-of cycle phenomenon and a lagging indicator in labour markets.

- Record recovery. Considering that the current US economic expansion is at its 102nd month, another two years would make it the longest expansion in more than 150 years. Definitely, a record that president Trump would want to claim.

There are several “perfect storms” for gold. The most plausible combination would be for US fiscal and trade policies to drive the twin deficits near 7% of GDP, Fed shows patience on inflation in order to not exacerbate any flattening of the yield curve and accelerate the run-up in short-term yields and in order to not ignite another unwanted appreciation of the US dollar.

Such a scenario would lift gold closer towards $1500 as early as end of Q4.


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