The federal reserve in the US has been shrinking its balance sheet and raising interest rates in .25% increments since dec 2015. However rates were kept at 0.25% for seven years from december 2008 to dec 2015 which is effectively 7 years of keeping rates at 0% to prevent a credit crunch recession which would have cleared out the financial system by culling the banking system and liquidating the excessive debt buildup since the 1970’s. The fed prevented this process and now the economic system has more debt than ever and sky high asset prices in stocks and property. There was one rate hike in dec 2015 to 0.5% and one more rise in 2016 to 0.75% but the rate rises gained pace in 2017 when three more 0.25% raises occured to leave rates at 1.5%.
Things changed in 2018 however when the fed raised rates four times to leave rates at 2.5%. In conjunction with monthly balance sheet reductions by the fed the markets began to worry that that the federal reserve might no longer be in the business of blowing bubbles. Since the runup in stocks since the start of this decade is directly linked to the trillions of dollars the fed has printed and pumped into the market along with keeping rates at an effective 0% any change in this policy clearly leaves stocks with only one way to go.
The Dow Jones reached an all time high of 26743 on sep 21 2018 one week before the fed raised rates from 2% to 2.25%. For the next two months the Dow Jones fell almost continously to 22445 on dec 21st two days after the fed raised rates again to 2.5%. These market falls are predictable when the fed tries to end easy money policies but the problems always emerge when you try to remove the drugs from the addict. The fed under Powell appears to be trying to normalise rates before the next recession so they have some room for manouvere when that downturn (already overdue by historical norms) occurs. The market has recovered some of its losses in the last month based on the hope that the fed will lose its nerve and stop raising rates. The problem here is that there is always a timelag before interest rate changes start to really impact the economy and those timelags can vary between 12 and 24 months. This means that the US economy is still to feel the effect of the 7 most recent hikes since march 2017.
So the fed is stuck in a difficult position – if it backs off further rate hikes in 2019 it will lose credibility in the eyes of the market and trap itself in a corner when the next recession arrives. But the market turmoil at the end of 2018 is a clear warning that further hikes will cause a meltdown in those assets which benefited the most from 0% rates, namely stocks and housing. Weakness in stocks in particular is going to have a positive impact on the gold price as this has been the historical pattern. It is commonly thought that rising rates are bad for gold but the historical data does not support that interpretation at all. If rates were decisive then why did the gold price not soar in the period from 2009 to 2019 when rates were at 0.25% for most of that period? Or why did gold prices rise in the 1970’s when rates were much higher than today and trended higher over most of that decade? And the opposite applied in the 1980’s when rates peaked in 1981 and then fell for the rest of the decade mirroring the gold price.
It seems reasonable to suggest that the historical data suggest that the coming years are likely to be better for gold than the last decade has been and that this will correspond strongly with a stock market
Written by Shane Carroll – CEO Goldbank.ie
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