The
Federal Reserve’s endless machinations really affect the gold price,
sometimes confounding traders with seeming illogicalness. This week
the Fed cut rates again, which has really boosted gold in the past.
Yet it plunged 1.7% in less than an hour after this latest
decision! While gold’s Fed reactions often look capricious, there’s
a method to this madness. Traders need to understand why gold moves
on Fed actions.
The
day before this Wednesday’s latest policy decision by the Fed’s
Federal Open Market Committee, I warned our weekly-newsletter
subscribers about the downside risks to gold even if the Fed cut
as widely expected. “If the Fed doesn’t prove dovish enough, gold
is really at risk of starting another downleg given specs’
gold-futures bets.” What the FOMC actually does is multi-faceted,
with multiple avenues to affect gold.
The
FOMC meets 8 times per year to make monetary-policy decisions, about
every 6 weeks. While these meetings run 2 days, the actual
decisions are always released Wednesdays at 2pm New York time. The
media focuses heavily on what the FOMC does with the federal-funds
rate it controls, but that’s rarely any surprise. Both Fed
officials and federal-funds-futures trading telegraph hikes and cuts
well in advance.
The
collective trading in the federal-funds-futures market creates
implied probabilities of what the FOMC is likely to do in its next
meeting. The members of the FOMC who make rate decisions, Fed
governors and an annually-rotating subset of regional Fed
presidents, closely watch federal-funds futures. The Fed almost
always does what the markets expect when the implied odds exceed
70% going into any decision.
Between the previous FOMC meeting in late July and this week’s
decision, the futures-implied odds for a second rate cut this week
averaged 94%! So the Fed pretty much had to cut again, even though
it wasn’t justified economically, to meet traders’ expectations. If
they universally expected a cut but the Fed failed to deliver, the
stock markets would likely plunge sharply. So the FOMC almost never
risks surprising traders.
Thus
whether the Fed hikes or cuts isn’t usually what moves gold, those
decisions are already priced in leading into FOMC meetings. It is
several other things accompanying Fed decisions that interact with
the collective expectations of gold-futures speculators that
determine how gold will react. These are FOMC statements, so-called
dot plots, and the Fed chairman’s press conferences now following
each decision.
FOMC
statements are what detail policy decisions, a few paragraphs
released at 2pm. They explain what the Fed is seeing in the US
economy, whether it decided to change anything, and whether it is
likely to act in coming months. They also detail which of the 10
active FOMC members voted for or against what the committee decided
to do. Usually little changes in FOMC statements between meetings,
they seldom surprise.
The
big changes come in the dot plots, what traders call a
particular chart in an accompanying document called the Summary of
Economic Projections. SEPs are only published at every-other FOMC
meeting, so once a quarter. These are the Fed decisions near
calendar quarter-ends. Dot plots chart where every individual top
Fed official expects the federal-funds rate to be this year and in
each of the coming several years.
These dot plots are never accurate forecasts, the Fed governors and
presidents are constantly changing their minds. Top Fed officials
often try to downplay the dot plot, warning it is not an official
FOMC outlook but just summarized individual opinions. Nevertheless
the dot plots are highly anticipated by traders, and are what
they use to decide whether the FOMC is trending more hawkish or
dovish than they expected.
Most
of the times gold moves significantly either way on Fed decisions,
it is due to the dot plot implying more or less rate hikes or cuts
than traders were looking for at the time. More hikes or fewer cuts
are hawkish, boosting the US dollar which leads gold-futures
speculators to sell. Fewer hikes or more cuts are dovish, hitting
the dollar which sparks gold-futures buying. The dot plot is where
most of the action is!
The
dot plot is released right at 2pm at every-other FOMC decision. The
Fed chairman used to hold a press conference after every-other
meeting too, on that dot-plot schedule. But in June 2018, the
current Fed chairman Jerome Powell announced he’d start talking to
reporters and taking their questions after every FOMC decision
from January 2019 on. These press conferences are televised live
starting at 2:30pm.
Traders carefully listen to what Fed heads say, parsing whether they
appear more or less hawkish or dovish than expected. So though it’s
rarer than dot-plot spawned gold-futures trading, gold can move big
on what Fed chairmen are saying. The particular thing often goading
speculators into buying or selling are apparent changes in the Fed’s
future rate trajectory. Watching all this unfold in
real-time is fascinating.
Gold
rallied back up to $1509 heading into this Wednesday’s FOMC
decision. That wasn’t because gold-futures speculators were looking
for a universally-forecast rate cut, but since they figured the Fed
would imply still more cuts coming in the months ahead. Gold
plunged from $1509 just before 2pm to $1484 about 50 minutes later,
that sharp 1.7% intraday drop, because of what the newest quarterly
dot plot revealed.
The
prior one released in mid-June was a major shift from a
tightening bias to an easing one. At that point the top Fed
officials’ 2019 outlook for the federal-funds rate stayed neutral,
but their 2020 one shifted from a single additional hike next year
to one cut. That heralded the end of the latest rate-hiking cycle,
and the dawn of a new rate-cutting one. Then in late July between
dot plots the FOMC made that initial cut.
Since the FOMC had gone from no FFR changes in 2019 to cutting at
its very next meeting in late July, and was universally expected to
cut again this week, traders figured this week’s newest dot plot
would start to show more cuts coming. But they were
disappointed, as the Fed officials’ 2019 outlooks averaged together
left the FFR at the same 1.88% it was set to at this meeting. There
were no more cuts implied in 2020 either.
It
was that hawkish surprise that goosed the US dollar and
hammered gold, no more rate cuts implied this year or next. It was
close though, with 7 of 17 top Fed officials seeing one more cut
appropriate later this year. If not for that narrow minority, gold
would’ve plunged much further. About an hour later during Powell’s
press conference, gold was rescued and rebounded somewhat to a
relatively-minor 0.6% daily loss.
In
answering a reporter’s question, he declared “it is certainly
possible that we will need to resume the organic growth of the
balance sheet earlier than we thought.” That was a hint the FOMC is
considering restarting quantitative easing, conjuring money
out of thin air to buy up bonds! The prospects of QE4 are what
mitigated that dot-plot-hawkish-surprise gold selloff, and reversed
the stock markets higher as well.
So
gold’s reaction to FOMC decisions may seem random, but it’s usually
fairly logical. If the Fed is more hawkish or dovish than
gold-futures speculators expected, then gold is going to move
accordingly. And that is usually determined based on the quarterly
dot plot, although Powell’s pressers are growing in importance since
they now happen after every FOMC meeting. The Fed’s gold-bull
impact can be gamed.
This
first chart superimposes this current gold bull over the
federal-funds rate since early 2016, just after gold resumed
powering higher. Every FOMC rate hike and cut in that span is
noted, and whether the dot plot that accompanied it was more hawkish
than traders expected, more dovish, or neutral. Gold reacted
accordingly, and will behave similarly around future FOMC decisions
based on how they match expectations.
Way
back in December 2008 during that first stock panic in a century,
the FOMC panicked too slamming the FFR to zero. That fateful
zero-interest-rate-policy day, the Fed changed its hard FFR target
to a quarter-point range. Thus all FFR levels since are an
average of the range’s top and bottom. This week for example, the
FOMC cut to a 1.75%-to-2.00% range. The midpoint of that is 1.88%,
which is shown here.
During the panic, the FOMC had advertised ZIRP as a temporary
crisis measure. But long after that crisis passed and stock
markets soared into a powerful new bull, Fed officials lacked the
courage to normalize rates. So for 7.0 years continuously, the
federal-funds rate ran at 0.13%. The FOMC finally hiked again in
mid-December 2015, which was its first rate hike in 9.5 years. That
whole episode greatly affected gold.
In
late October 2015, gold was trading near $1182 heading into a 2pm
FOMC decision. Its statement had a sentence declaring “In
determining whether it will be appropriate to raise the target range
at its next meeting...” Those last 4 words were new, and
gold-futures traders fled on the prospect of the first rate hike in
nearly a decade in just 7 weeks. Gold plunged 8.4% over the next
several weeks on heavy selling.
The
Friday before that first rate-hiking decision, I published a study
on how gold fared
in rate-hike cycles historically. Contrary to popular worries,
it had averaged strong 26.9% rallies during the exact spans
of the 11 previous Fed-rate-hike cycles! So a new hiking cycle
would actually prove quite bullish for gold. Still gold plunged
2.1% to a dismal 6.1-year secular low the day after the FOMC finally
lifted rates out of ZIRP.
Though that final swoon birthed the gold bull since, it was actually
a hawkish dot plot that spawned that immediate gold-futures
selling. Heading into that mid-December-2015 FOMC decision, traders
were looking for 3 more rate hikes forecast in 2016. But top Fed
officials collectively saw 4 rate hikes that year, kicking off the
last hurrah of bear-market gold-futures selling. That dot plot, not
the hike, is what surprised traders.
Gold
soared 29.9% higher over the next 6.7 months in this bull’s mighty
maiden upleg, stalling out around $1350 upper resistance. It was
correcting normally until Trump’s unexpected election victory later
that year. Hopes for big tax cuts soon from the new
Republican-controlled government unleashed a major stock-market
rally, which motivated gold-futures speculators to sell with
reckless abandon. Gold cratered.
By
mid-December 2016 its correction had cascaded to a monster 17.3%
over 5.3 months! Though that was shy of the -20% new-bear threshold
so gold’s bull was still intact, few believed it at the time. After
waiting an entire year, the timid FOMC finally hiked a second time
confirming a rate-hike cycle was underway. Again gold
bottomed the very next day, after briefly selling off again on
another hawkish dot plot.
Top
Fed officials were collectively expecting 3 more rate hikes in 2017,
up from 2 in the previous dot plot a quarter earlier. Gold dropped
1.2% that day on that unexpected hawkishness, but then started
climbing higher in a 20.4% upleg that would last 13.3 months. The
next 3 rate hikes of that young hiking cycle didn’t sink that
upleg. Rate hikes and cuts on their own aren’t necessarily bullish
or bearish for gold!
The
FOMC’s 3rd rate hike came a quarter later in mid-March 2017. At
that point the Fed-chairman press conferences only came after
every-other meeting, so no rate decisions were made at the off
meetings as they couldn’t be explained afterwards to calm anxious
traders. That dot plot was actually dovish, as top Fed officials’
speeches leading into that decision left traders expecting another
hike would be added in.
Yet
that dot plot came in unchanged from the prior one, still implying 3
total rate hikes in 2017. That
less-hawkish-than-expected-and-therefore-dovish dot plot ignited a
5.6% gold surge over the next 5 weeks or so. The FOMC’s 4th rate
cut a quarter later in mid-June 2017 was accompanied by a neutral
dot plot, the Fed was still signaling 3 total hikes in 2017. But
gold fell 3.8% over the next few weeks for another reason.
It
was that FOMC meeting where the Fed warned it was going to start
unwinding the staggering $3625b of money printing it had done over
6.7 years through several QE campaigns.
Quantitative
tightening was erroneously seen as a threat to gold then. But
gold soon rallied out of the summer doldrums before the Fed hiked
the 5th time mid-December 2017. With another neutral dot plot, gold
rallied sharply out of lows.
The
top Fed officials’ collective rate forecast stayed unchanged from
the prior dot plot, implying 3 more rate hikes in 2018. Due to
Fedspeak and market developments, gold-futures speculators had
expected that to rise to 4. So that neutral dot plot was still
effectively a dovish surprise, kicking off another sizable
gold rally. See the pattern here? Gold sells off on dot plots
perceived as hawkish, and rallies on dovish ones.
The
FOMC’s 6th rate hike of that latest tightening cycle came a quarter
later in late March 2018. That was another neutral dot plot, not
budging from the prior couple’s forecast of 3 total rate hikes that
year. So gold drifted sideways after that before rolling over into
a healthy bull-market correction. Gold was stabilizing near its
200-day moving average until the Fed’s 7th rate hike another quarter
later in mid-June 2018.
Yet
again that rate hike was well-telegraphed in advance and fully
priced in in federal-funds futures, so it was no surprise. But the
dot plot waxed considerably more hawkish, with top Fed officials’
outlook for the FFR climbing to 4 total hikes in 2018 instead of the
previous 3. That ignited sizable gold-futures selling, which soon
snowballed into the most-extreme
gold-futures
short selling ever witnessed hammering gold!
While gold-futures-trading momentum can take on a life of its own,
FOMC surprises which usually come in the dot plot can kick off these
short-term trends. The Fed’s 8th hike came the following quarter
with the next dot plot in late September 2018. Gold was pretty
stable after that one as the dot plot again came in neutral, with 4
total rate hikes expected in 2018, 3 more in 2019, and a single
final one way out in 2020.
A
new gold upleg driven by gold-futures buying to normalize
speculators’ excessively-bearish bets was well underway by the Fed’s
9th hike in mid-December 2018. Again that hike was universally
expected, but the dot plot came in dovish. The rate-hike forecast
for 2019 and 2020 moderated from 4 more hikes to 3. The resulting
gold rally was greatly boosted by a sharp plunge in stock markets
after that particular dot plot.
How
traders view dot plots is always dependent on what they expected
going in. Stock traders were way more dovish than gold-futures
speculators heading into that one, as stock markets had really
weakened on hawkish Fedspeak in previous months. Stock traders
expected Fed officials to strike 3 of the future hikes, leaving just
1. When they only got a third of that, US stock markets plunged.
That carnage boosted gold.
By
late December last year, the flagship US S&P 500 stock index had
plummeted 19.8% to the edge of new-bear territory in just 3.1
months! The final third of that collapse came in 4 trading days
after that dot plot came in not-dovish-enough for stock traders.
Fed officials are terrified of sparking a stock-market selloff that
damages confidence spawning a recession, so they reversed course
hard this year to goose stocks.
The
FOMC paused its rate-hiking cycle, and at its late-March-2019
meeting Fed officials slashed their rate-hike outlook. The dot plot
went from showing 2 more rate hikes in 2019 to zero this year,
leaving a single final one out in 2020. But since that was
expected, it wasn’t really a dovish surprise so gold didn’t move
much. But the next dot plot a quarter later changed everything for
gold, launching a huge breakout.
Despite still being in a bull market technically, few believed gold
was. It hadn’t made a new bull high in 2.9 years, and was trapped
under seemingly-impregnable $1350 upper resistance. It was the
mid-June-2019 FOMC meeting’s dot plot that finally catapulted gold
to a long-overdue
decisive bull-market breakout from there! That dot plot left
2019 neutral with no hikes nor cuts, but replaced 2020’s lone hike
with one cut.
Fed
officials’ outlooks were officially shifting from tightening to
easing mode, a radical reversal compared to how they felt just a
half-year earlier at their 9th hike. That later proved the end of
that hiking cycle, 9 hikes for 225 basis points over 3.0 years.
Gold fared well in its exact span, rallying 17.0%. FOMC rate hikes
were never a threat for gold, despite what traders feared before
that tightening cycle first started.
At
the FOMC’s next meeting in late July 2019 between dot plots, the Fed
cut its federal-funds rate for the first time in 10.6 years! That
too was expected, and gold actually fell during the Fed chairman’s
press conference when he declared that cut was a “midcycle
adjustment” and not “the beginning of a lengthy cutting cycle”. But
gold resumed powering higher the next day on totally-unrelated
US-China trade-war news.
This
gold bull’s history surrounding FOMC decisions is clear, the
gold-price reactions generally aren’t unpredictable. They can be
gamed with the knowledge of where Fed officials were on their rate
outlook in the previous dot plot, what gold-futures speculators
expect, and whether the imminent dot plot is likely to show more or
less hikes or cuts. Gold generally surges on dovish surprises, and
sells off on hawkish ones.
There’s one more key factor to consider heading into FOMC meetings,
how gold-futures speculators are positioned. This last chart is
updated from last week’s essay where I explained why gold’s current
short-term outlook is bearish due to a massive
gold-futures-selling overhang. When speculators are almost
all-in longs and all-out shorts, their buying is exhausted. All
they can do is sell, regardless of what the Fed does.
Heading into this week’s latest FOMC meeting, total spec longs and
shorts were running 83% and 7% up into their bull-market trading
ranges. That was uncomfortably close to the most-bearish-possible
near-term gold setup of 100% longs and 0% shorts. So material
gold-futures selling was likely anyway, and just exacerbated by that
newest dot plot not being as dovish as expected in
coming-Fed-rate-cut terms.
It
is incredibly troubling and damning how much influence the Federal
Reserve holds over markets. How top Fed officials communicate
really bullies gold, currencies, and stock markets around. That
makes it absolutely essential to follow the FOMC. Once every
6 weeks, all speculators and investors need to get up to speed with
the prior meeting. They also need to check in on how gold-futures
speculators are betting.
Armed with that knowledge, gold’s likely reaction after any given
FOMC decision can be gamed. Gold’s reactions are logical, and based
on whether either the FOMC statement, dot plot if released, and
things the Fed chairman says at his press conference are more dovish
or more hawkish than expected. As long as Fed rate expectations
dominate short-term market action, traders are stuck having to watch
the Fed.
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The bottom line is
Fed actions have really impacted this gold bull, and will continue
to do so. This isn’t from the rate hikes or cuts themselves, which
are well-telegraphed and universally expected in advance. Markets
move based on changes implied in the outlook for the future rate
trajectory. That can spawn big buying and selling in gold futures,
leading to large and fast gold-price moves following FOMC decisions.
These rate-outlook
shifts usually come in Fed officials’ collective forecasts
summarized in the dot plots, but are sometimes seen in the Fed
chairman’s press conferences. Gold tends to surge if the Fed looks
more dovish than expected, and sell off if it comes across as more
hawkish. This is due to the reactions from the
gold-price-dominating gold-futures speculators. Their positioning
also impacts how they react to the FOMC. |