Will The Fed Move SLV?

| About: iShares Silver (SLV)


The price of SLV started off the year on a positive note - will this rally continue?

The FOMC meeting will convene this week to decide on its rate.

Will the FOMC meeting impact the direction of SLV?

After the rally of iShares Silver Trust (NYSEARCA:SLV) at the beginning of the year, the silver market cooled down a bit. The bearish market sentiment in the markets hasn't gone away and could still increase the demand for precious metals, which are conceived by many as protection against "tail risk events." And currently there are concerns that another global recession is looming over the horizon. This week, the Federal Reserve will take center stage again as the FOMC convenes for the first time since the December rate hike. How will the Fed's decision impact price of SLV?

A tale of two Feds

On the one hand, the U.S. economy shows signs of progress - mainly in the labor market. The last three NFP reports showed, on average, a gain of over 250K jobs; rate of unemployment is very low at 5%. And wages also slightly picked up to roughly 2.5%; wages were stuck around 2%-2.2% for several years. Since the share of net exports, as Bernanke pointed out in an article, from the GDP growth rate is very low, the impact of a stronger U.S. dollar - a trend is likely to persist if the Fed continues to raise rates - on the U.S. economy won't be severe.

In another blog post Bernanke points out that the Fed's job isn't to calm financial markets and it cannot do so using its available tools:

Under most circumstances, monetary policy is just too blunt a tool to use for financial stability purposes; it cannot be directed at some classes of financial assets and not others, or at financial markets only and not the real economy. Using monetary policy to manage financial stability risks is like trying to play the piano with a sledgehammer."

If the current FOMC Chair Yellen agrees with this assessment, then the Fed might just keep its stance of raising rates in the coming months - currently, the next hike could be as early as March.

And because the Fed is concerned over inflation expectations, FOMC members may want to be ahead of the curve and raise rates before inflation starts to catch up with expectations. These are some of the reasons to keep the hawkish line in the upcoming statement.

On the other hand, inflation is nowhere to be seen - even if we account for the core CPI. And even inflation expectations, while they have slightly risen in the past few months, are still well below the 2% target over the next 5 years. The labor market is recovering, but is far off from being robust. It could still easily dip into a slowdown. The real unemployment (U6) is still high at close to 10%. And wages have room to grow before they reach growth rates recorded before 2008. The bearish market sentiment could be driven not only because of China's economic woes, but also due to a belated reaction to the Fed's rate hike - at the very least, the December hike didn't help the markets. But for SLV, if the Fed releases a dovish statement in an attempt to cool down the markets, this could further boost its price. After all, lower long-term treasuries and weaker dollar could push back up precious metals in general and SLV in particular. Since the beginning of the year, LT treasury yields have declined - a trend that helped pull back up SLV prices.

But if the Fed doesn't change the tone of its statement and keeps stating that it will maintain its course of raising rates this year, this could prompt selloffs of SLV. And so far this year, despite the rally of the price of silver, SLV's silver holdings have declined over the past couple of months. Part of these selloffs could be related, among others, to pay off the ETF's expenses, but this trend doesn't vote well for the direction of this ETF.

Source: SLV's website

Keep in mind, in the December meeting, FOMC members estimated the cash rate will reach 1.375% (the median outlook) by the end of the year. The market doesn't agree with this assessment. And based on the Fed-watch calculations, the market expects the rate will only reach 0.68% by the end of the year - this implies one rate hike this year.

Final point

The Fed will keep impacting the direction of SLV. The bearish market sentiment and expectations for lower rates than previously estimated are keeping the price of SLV up; all awhile the appreciation of the U.S. dollar against major currencies is holding it back. But if the Fed were to release a dovish statement - and the markets currently expect - this could prompt another boost for SLV. For more please see: What's Up Ahead for Silver in 2016?

Disclosure: I/we 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.

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