Expect the Unexpected from the Fed

[GoldCore]

It has been a rough week in most markets with both equities and bonds declining sharply.

Tech stocks have been pummeled with many ‘big names’ plunging more than 50% (from their 52-week high). They are Zoom Video -75%, PayPal -73%, Netflix -72%, Meta Platforms (Facebook), -53%.

The equity market decline is coupled with announced layoffs. Robinhood, the popular online trading platform, announced a 9% reduction in full-time staff this week for example.

Markets are expected to decline further as earnings continue to be announced.

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With U.S. equity markets on the verge of correction territory and the U.S. yield curve close to inversion the Fed’s predicament becomes even more precarious as they head into their meeting next week.

What Will Happen in the Next Fed Meeting?

Market expectations (97% probability according to the CME FedWatch Tool) are that the Fed will increase the fed funds rate by 50 basis points at the May 4^th meeting and many expect that the Fed will continue increasing rates each meeting the rest of this year – pushing the Fed funds rate to over 3%.

We have been skeptical of the Fed’s ability to do this for quite some time – see “The ‘Fed put’ – Gone Until There’s Blood in the Streets” where we commented:

“We are still skeptical that the ‘Fed pivot’ to tighter policy faster is a one-way pivot and that the Fed will not back-track.

The Fed gets scared if stocks fall another 10%, if so, it will not tighten policy as quickly as the markets currently expect.

Remember all that government debt still exists; that the interest payment must be paid on that debt, and higher interest rates mean higher payments.

There is also the housing market to consider, yes it might be bloated but a housing crash is not something the U.S. administration would be pleased about heading into mid-term elections.”

Three things to keep in mind heading into next week’s meeting:

1. Gold and Silver continue to find support at higher levels than before mid-February despite rising interest rates. Both realized and expected a sharply higher U.S. dollar, and falling equity markets.

Meaning that gold and silver are doing exactly what they should do in a selloff in stocks and bonds and heightened geopolitical risk.

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2. The recent selloff in equities combined with the almost inverted yield curve which both points to the recession, and the destruction of the wealth effect.

This will keep the Fed tentative and not as aggressive as some have predicted.  

The pattern of the U.S. yield curve inversion following a recession is seen in the chart below.

US Yield Curve Chart

3. Economic growth concerns still abound. Also, the resurgence of Covid-19 in China and the imposition of strict lockdowns have heightened the concerns for global economic growth.

The escalation of the war in Ukraine is also a global geopolitical concern.

The latest development is that Russia will cut gas supplies off for countries that do not meet its demand to pay in rubles. Currently, it is targeted at Poland and Bulgaria. That will push energy prices higher – European energy prices have already surged 17% in one day.

The further disruption to the supply chain due to the lockdowns in China and Russia’s threats to cut gas supplies off will give the Fed more reason to “pivot” back to its message of inflation being transitory and will slow interest rate increases.

Bottom line: Yes – the Fed will likely still increase interest rates by 50 basis points the markets expect next week.

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However, the messaging around the hike could look quite different in light of the equity market sell-off, declining bond yields, and heightened geopolitical risks. In other words, the “Fed Put” could be back on the table – which is positive for Gold and Silver Investors.

Positivity for physical metals comes from the following idea;

There are less than an infinite number of times that central bankers can pretend to fight inflation whilst also being the true cause of inflation.

Someday everyone, and not just Goldcore customers, will see silver and gold as better tools to protect themselves versus owning cash or bonds.