Although gold has not been able to extend its recent rally, the market could potentially be turning a key corner that could pave the way for a more sustainable run higher. A number of issues currently in play could set the stage for an upside breakout from recent highs and such a move could be swift and severe.
The Federal Reserve has taken a decidedly more-dovish tone in recent months and has now taken all rate hikes off the table for the year. Given many of the symptoms of a global slowdown, this is not all that surprising. What perhaps is a bit surprising, however, is the notion of the central bank cutting rates this year. After all, it was not long ago that the Fed had another three rate hikes penciled in for 2019 and that its balance sheet contraction would be on autopilot. How quickly markets can change…Markets are now pricing in over a 50% chance of a rate cut by the end of the year.
The Federal Reserve has tried to maintain its independence in recent months as it has endured a barrage of criticism from President Trump. As the global slowdown has increased in intensity, Trump is now calling for the central bank to implement QE4. It is unclear if such action will become necessary. After a solid non-farm payrolls report last week, some analysts have suggested that recent economic weakness is transitory in nature and that the economy remains on solid footing. Whether it is in fact necessary or not, there are other factors at play as well-namely the 2020 Presidential election.
Trump knows that if the U.S. does in fact enter a recession, his chances of becoming reelected may decline significantly. He also understands the power of loose monetary policy and how it may keep the economy and markets moving higher through his reelection campaign. Put simply: higher markets may mean reelection while lower markets or recession could mean no reelection.
The Fed has thus far done its best to avoid getting involved in politics. Despite being a frequent target of Trump’s displeasure, Fed Chief Jerome Powell has continued to conduct policy as the central bank sees fit according to the data and other factors. Given the Fed’s recent about-face, however, you have to wonder if the central bank is starting to bend a bit to political pressure. On the other hand, the global slowdown may just be a greater cause for concern than many anticipated and the Fed is seeing just how weak it really is.
Regardless of the Fed’s motivations and whether it is forced to cut rates or not, borrowing costs are not likely to go significantly higher any time soon. The current 2.25%-2.50% Fed Funds rate is only about half of what rates were prior to the 2008/2009 financial crises. Not only is the economy’s inability to handle higher rates a cause for concern, but the Fed will have far-less ammunition this time around if it decides to start cutting again.
The notion of an ongoing period of low rates and possibly even more quantitative easing could potentially keep the gold market well-supported in the months and years ahead as the dollar is likely to weaken substantially.