Grilled Yellen and Gold

Janet Yellen was grilled yesterday before the Congress on the Fed’s partisanship. What does it imply for the gold market?

Yesterday, Yellen testified before the Committee on Financial Services of the U.S. House of Representatives. She spoke about supervision and bank regulation, and did not comment on the outlook for the economy or monetary policy in her prepared remarks. There were a lot of questions over Wells Fargo and other supervisory issues, however, investors should not ignore the event. Why?

First, modifications in stress tests are likely as Yellen said the Fed is “now considering making several changes to our stress testing methodology and process.” What is important is that for the eight largest and systematically important U.S. banks it “would result in a significant aggregate increase in capital requirements.” It seems like bad news for the stock market, however, the Fed wants to make stress tests easier for all but the giant banks.

Second, Yellen was asked about raising the inflation target. She said that it is an appropriate subject to do more research on, but not something the FOMC is actively considering. Instead, she hinted that the Congress could make a small change in the law to enable the Fed to broad the range of assets it can purchase. Her response to the question whether the Fed is looking at the possibility of adding equity purchases to its tool box as it looks at monetary policy was as follows:

“Well, the Federal Reserve is not permitted to purchase equities. We can only purchase U.S. treasuries and agency securities. I did mention in a speech in Jackson Hole, though, where I discussed longer term issues and difficulties we could have in providing adequate monetary policy. Accommodation may be somewhere in the future, down the line that this is the kind of thing that Congress might consider, but if you were to do so, it’s not something that the Federal Reserve is asking for.”

Third, Yellen discussed a rate increase this year. She said that the Fed does not have a “fixed timetable” for interest moves, but also pointed out that many of her Fed colleagues had indicated in their recent projections that it would be appropriate to remove some of that accommodation this year if no significant new risks arise. Indeed, other Fed officials were even more explicit about a rate hike this year. For example, Cleveland Fed President Loretta Mester said that the U.S. Federal Reserve should not delay interest rate hikes given the progress the economy has made and risks getting “behind the curve”. The market odds of a rate hike in December 2016 rose from 44.1 percent to 48.2 percent.

Last but not least, Yellen was grilled about the Fed’s independence. Congressman Scott Garrett accused the Fed of acting politically this campaign season. In particular, he pointed out that Fed Governor Lael Brainard, the same who made a very dovish speech this month, donated the legal maximum to Hillary Clinton’s campaign and may seek a top-job in the potential Clinton administration. Yellen was pushed to the wall and replied that while she would need to check with Fed lawyers, she didn’t see any conflict of interests. The truth is that the Fed is not fully independent and we repeated several times before the September FOMC meeting that history shows that the U.S. central bank tries to avoid, if possible, any major monetary actions as an election approaches.

The key takeaway is that Yellen testified before the Congress. Although her testimony was rather boring as it touched upon supervisory and regulatory issues, there were a few interesting and insightful moments. The Fed wants to make stress tests easier for all but the giant banks and it would prefer to broaden the range of purchased assets rather than raise the inflation target as the next unconventional step when the recession strikes again. Moreover, Fed officials reiterated their willingness to hike interest rates this year, just after the presidential election, which is a total accident as the Fed is completely non-political (only some of their governors have cozy relationships with one of the candidates). It is rather bad news for the gold market. Stocks declined during Yellen’s comments, but gold also slipped a bit yesterday in the face of hawkish comments from the Fed officials, a better-than-expected report on durable goods orders, and the rise in the market odds of a rate hike in December.

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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.

Thank you.

Arkadiusz Sieron
Sunshine Profits‘ Gold News Monitor and Market Overview Editor

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