Will The Fed's Policy Drag Down Silver?

| About: iShares Silver (SLV)


The silver market has heated up last week, which also pulled up silver ETFs such as iShares Silver Trust (SLV) and silver investments such as Silver Wheaton (SLW).

The weakness of the U.S dollar against the euro and Japanese yen may have also indirectly pulled up the price of silver.

This week the FOMC will convene and decide whether to taper QE3 again. This decision could curb down silver’s recent recovery.

The price of silver changed course and bounced back during last week. But will the recent rally of silver continue? Let's examine the recent news that may affect silver and the silver ETFs.

The recent rally of silver has reflected in the rise in demand for silver ETFs such as iShares Silver Trust (NYSEARCA:SLV). During last week, the Silver Trust's price increased by 2.7%. Other Silver investments such as Silver Wheaton (NYSE:SLW) also rose by 6.1%. Looking forward, the upcoming FOMC meeting economy and the direction of the U.S dollar could be among the factors affecting the silver market. Let's further explore these issues.

FOMC's monetary policy

In the upcoming FOMC meeting (between March 17th and 18th) its members will decide whether or not to taper again the Fed's asset purchase program. The current expectations are that the FOMC will taper QE3 by $10 billion. Thus, the long-term asset purchase program will drop to $55 billion a month. After all, the recent non-farm payroll report was slightly better than anticipated and the FOMC is likely to maintain its line of slowly reducing its asset purchase program.

In the past couple of meetings, following the FOMC's decision to taper QE3, the price of silver tumbled down. As indicated in the table below.

Source: FOMC's site and Bloomberg

The table above shows the decisions of the FOMC in the past couple of years, and the reaction of silver price the day of the announcement and the following day. Based on the above, if the FOMC tapers again QE3, this could result, all things being equal, in a short term adverse effect on the price of silver.

In the meantime, the potential tapering of QE3 again doesn't seem to draw much attention: The chart below presents Google Trends for the word "tapering" in the past month.

Source: Google Trends

As you can see, the word tapering hasn't been trending high in recent weeks. This could suggest that the uncertainty around the FOMC's next move isn't high.

Besides the tapering decision, the Federal Reserve's future plans as to when to raise the cash rate could stir up the markets, especially if Federal Reserve Chair Yellen addresses this issue in the press conference following the release of the Fed's statement. If the Fed pushes back the interest rate raise, this could have a negative effect on silver. My guess is that the Fed won't change its guidance about the cash rate, despite the decline in the rate of unemployment to 6.7% in the past several months. As stated in the FOMC's minutes of the last meeting:

"Members also agreed to reiterate language indicating the Committee's anticipation…that it would be appropriate to maintain the current target range for the federal funds rate well past the time that the unemployment rate declines below 6-1/2 percent, especially if projected inflation continues to run below the Committee's longer-run objective."

Besides the FOMC's decision, the developments in the foreign exchange market could also play a secondary role in the progress of the price of silver.

Silver and currencies

During last week, the US dollar depreciated against euro and Japanese yen but slightly appreciated against the Australian dollar and Canadian dollar. The chart below presents the linear correlation of the daily percent shifts of silver and leading currencies pairs during the past several weeks.

Source: Bloomberg

As you can see, the linear correlation between Euro/ USD and silver are mid-strong and positive. But if the FOMC tapers again QE3, this could pull up the U.S dollar. Thus, assuming all things equal and under certain assumptions, if the US dollar changes course and appreciates against the Euro an other leading currencies, this could curb the recent rally of silver.

Bottom line

Based on the above, the price of silver might change direction and fall especially if the FOMC decides to taper QE3 again. Moreover, FOMC Chair Yellen will address the recent economic developments in the U.S, the Fed's updated outlook and future plans about the Fed's interest rate. If she will hint of a chance of pulling up the cash rate in the near future, this could have an adverse effect on the silver market.

Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.