The Fed Had No Choice - Timing Is Everything
Summary
- The move in 2019.
- The Fed wanted to remain neutral on rates.
- Coronavirus changes the game.
- The market and administration were screaming at the central bank, and that will continue.
- Lower rates will lead to a golden explosion - UGLD turbocharges results.
- Looking for more stock ideas like this one? Get them exclusively at Hecht Commodity Report. Get started today »
In 2018, the US central bank went a bit too far when it hiked the short-term Fed Funds rate four times for a total of a full percentage point. The rate hikes came as the rote program of balance sheet normalization continued to push rates higher further out along the yield curve. In the final quarter, risk-off conditions gripped markets in a sign to the Fed that they became a bit too over enthusiastic hiking rates when the rest of the world did not join the tightening party.
With the trade war between the US and China escalating in 2018 and through 2019, and Brexit approaching, fear and uncertainty rose causing markets to hit lows during the final week of 2018, The Fed got the message and reversed course in 2019.
Central banks around the world became addicted to using their monetary toolboxes to stimulate economic conditions. Under the Trump Administration in the United States, tax and regulatory reforms injected fiscal stimulus into the economy, which led to GDP growth, falling unemployment, and rising corporate earnings. The US depends on the rest of the world for economic expansion, but few central banks followed the US lead. In 2019, the US central bank realized that it had pushed the envelope a bit too much.
Lower interest rates since the 2008 global financial crisis create the conditions for a bull market in gold. The yellow metal waited until the Fed moved back to a dovish stance before it broke out to the upside last June in the next leg of a move to the upside that began in the early years of this century. Recent events have put the Fed in a position where it had no choice but to push interest rates even lower. On Tuesday, March 3, the Fed cut the Fed Funds rate by 50 basis points, citing uncertainty over the spread of Coronavirus and its impact on markets and the economy. The gold market continued to shine as falling rates have been bullish fuel for the precious metal. The Velocity Shares 3X Long Gold ETN product (UGLD) is a short-term tool that turbocharges percentage gains in gold when the price moves higher. Timing is everything in markets, and the question will now be, did the Fed act too soon?
The move in 2019
In June 2019, the Fed told markets to expect interest rate cuts by the end of the year. At the time, the Fed Funds rate stood at 2.25%-2.50%. The guidance alone caused the price of gold to move higher and above its level of critical technical resistance at the July 2016 peak of $1377.50 per ounce. The break to the upside came during the week of June 17, 2019.
They followed through on its guidance. It trimmed the Fed Funds rate by 25 basis points on July 31 and ended its balance sheet normalization program. The central bank cut rates by 25 basis points at its September and October meetings, sending the Fed Funds rate to 1.50%-1.75%.
Source: CQG
As the weekly chart highlights, gold continued to rise as the Fed reduced interest rates and shifted from a hawkish to dovish approach to monetary policy last year. Gold rallied to a high of $1559.80 in early September, which turned out to be the high for the year. In early 2020, the yellow metal rose to a higher peak on January 8 at $1613.30 as tensions between the US and Iran reached a boiling point. The most recent new high came on February 24 when the continuous contract reached $1686.60 per ounce, the highest price since January 2013, before risk-off conditions in markets across all asset classes sent the price of the yellow metal to a low of $1564 on Friday, February 28. All the while, the Fed Fund rate sat at 1.50% to 1.75%, but on the final trading session of February, Fed Chairman Jerome Powell signaled that the Fed was prepared to act given the rising concerns over the spread of Coronavirus.
The Fed wanted to remain neutral on rates
2020 is an election year in the US. Political divisiveness is likely to make the Presidential contest the most contentious in history. The Federal Reserve is an apolitical body, and it would have liked nothing more than to remain on the sidelines through at least election day in early November.
At the recent FOMC meetings, the Fed had told markets that monetary policy was "appropriate" and that there were no plans to make any adjustments to the Fed Funds rate. Any reduction or increase in rates or the use of other monetary policy tools could influence the election, which was something that the central bank attempted to avoid at all costs.
Tuesday, March 3, was one of the most critical days in the election cycle. The Democrats held the Super Tuesday contests in delegate-rich states, including California and Texas. The primaries have come down to a moderate and progressive choice. Many candidates dropped out and throwing their support behind the moderate, former Vice President Joe Biden. However, billionaire Michael Bloomberg spent hundreds of millions. He had the potential to eat into Biden's support, paving the way for another string of victories for the progressive Democratic-Socialist, Senator Bernie Sanders. The sharp correction in the stock market on February 24 came on the back of fears over Coronavirus, but it also occurred after a substantial victory by Senator Sanders in the Nevada Caucus on Saturday, February 22.
The Fed may have wished to remain neutral when it comes to the political landscape, but cutting the Fed Funds rate on March 3, Super Tuesday, came as a surprise. However, the market's reaction was also a shock as stocks declined in the aftermath of the emergency rate cut that sent the Fed Funds rate to 1.00%-1.25%.
The Fed may have chosen to cut rates before the Super Tuesday results to avoid any criticism. The former Vice President emerged as the leader after winning many of the primaries on March 3, and on March 4, Mayor Bloomberg stepped aside giving his support to Joe Biden. The stock market rose in the aftermath of Super Tuesday as the odds of a socialist administration in the White House declined.
Coronavirus changes the game
Coronavirus altered the landscape for the US Federal Reserve and central banks around the world. The Fed rate cut may be the first shoe to drop as the ECB, and other central banks are likely to follow by adding liquidity to the financial system. Australia cut its rates by 50 basis points before the Fed acted on Tuesday.
The threat of a global pandemic is jeopardizing the worldwide economy. Fear and uncertainty over the spread of the virus around the globe, the rising number of fatalities and cases threatens the supply chain and productivity. Chairman Powell said that the Fed realized that a rate cut would not stop the spread of the virus or impact on the global supply chain but would provide some comfort for the economy.
While the battle between President Trump and his opposition party challenger will be contentious, the selection of a nominee between a progressive and moderate candidate is also increasing tensions amongst Democrats. I continue to believe that risk-off conditions are at least in part the result of the political division in the US, which may result in an election that pits capitalism versus socialism. However, the odds of that decreased with the outcome of the Super Tuesday primaries and withdrawal of Mayor Bloomberg from the race.
The market and administration are screaming at the central bank, and that will continue
The Fed found itself with its back against the wall before it decided to cut rates by 50 basis points on March 3 in an emergency move. The market had already baked in the cut to prices over the past week as it faced risk-off conditions. In the aftermath of the rate reduction, President Trump tweeted:
Source: Twitter
The pressure from the White House was nothing new. With rates in Europe at negative fifty basis points and heading lower, the President will continue to pressure the Fed to push rates lower over the coming days and weeks. However, at 1.00%-1.25%, there is not much room before the prospects of negative interest rates begin to rise.
The path of least resistance for interest rates has been lower since the Fed changed its posture toward monetary policy in mid-2019. The odds of even lower rates rose on March 3, and that is rocket fuel for the gold market.
Lower rates will lead to a golden explosion - UGLD turbocharges results
The price of gold dropped from $1691.70 to $1564 on the April futures contract from February 24 through February 28. By March 4, the price of the yellow metal was back above the $1650 level and traded to a high of $1654.30 per ounce in the aftermath of the Fed rate cut.
Before the risk-off period in markets began at the end of February, Citigroup analysts had forecast that the price of gold would rise to over the $2000 per ounce level over the coming twelve to twenty-four months. Falling interest rates and fear and uncertainty over Coronavirus and the political future of the United States could move up the timetable on Citigroup's target price for gold.
Gold moved to all-time highs in most currency terms over the past months. The only two leading currencies that did not experience a new record level in the yellow metal were the Swiss franc and the US dollar.
The path of least resistance of the gold market remains higher and falling interest rates are supportive of more gains in the price of the yellow metal. If gold preparing to take off on the upside, again, the Velocity Shares 3X Long Gold ETN product is a product that will turbocharge percentage gains on the upside. The fund summary for UGLD states:
The investment seeks to replicate, net of expenses, three times the S&P GSCI Gold Index ER. The index comprises futures contracts on a single commodity. The fluctuations in the values of it are intended generally to correlate with changes in the price of gold in global markets.
Source: Yahoo Finance
UGLD has net assets of $216.89 million, trades an average of 123,822 shares each day, and charges a 1.35% expense ratio. The price of gold rose from $1564 on February 20 to a high of $1650.50 on March 3 or 5.53%.
Source: Barchart
Over the same period, UGLD rallied from $149.52 to $174.64 per share or 16.8% on March 3, which was just over a triple percentage gain compared to the gold futures market over recent sessions.
The Fed had no choice but to cut rates on March 3, and other central banks around the world are likely to follow over the coming days. Time will tell if the 50 basis point reduction in the Fed Funds rate will calm the stock market. However, the odds favor that the dovish move is highly supportive of the price of gold, which appears to be on a path to a new all-time high in Swiss franc and US dollar terms sooner rather than later.
The Hecht Commodity Report is one of the most comprehensive commodities reports available today from the #2 ranked author in both commodities and precious metals. My weekly report covers the market movements of 20 different commodities and provides bullish, bearish and neutral calls; directional trading recommendations, and actionable ideas for traders. I just reworked the report to make it very actionable!
This article was written by
Andrew Hecht is a 35-year Wall Street veteran covering commodities and precious metals.
He runs the investing group The Hecht Commodity Report, one of the most comprehensive commodities services available. It covers the market movements of 20 different commodities and provides bullish, bearish and neutral calls; directional trading recommendations, and actionable ideas for traders. Learn more.Analyst’s 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.
The author always has positions in commodities markets in futures, options, ETF/ETN products, and commodity equities. These long and short positions tend to change on an intraday basis.
The author is long gold
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