6/17/2021 9:00am EST - Trading Lab Morning Email

Yesterday, the Federal Reserve acknowledged the higher levels of inflation that have become obvious in the last few months. The FOMC also signaled the potential for a first rate hike roughly two years from now, and the potential for two rate hikes in 2023. This means that the so called "tapering" process (gradually slowing Fed open market purchases of MBS and treasuries) could begin sometime in the middle of next year.

The equities market did not like this tighter monetary policy posture from the Fed. However, the real story of the day was the massively flattening yield-curve (short rates moved up a lot while long rates didn't move much), a surge in the US dollar, and a crash in precious metals like gold, platinum, and silver.

See if you can spot when the FOMC statement came out on this 15-minute chart of gold:

There are several points I want to make this morning regarding the Fed announcement and the subsequent gold price action:

  • The Fed primarily tightens monetary policy by using the concept that the "threat is stronger than the execution" - in other words, threatening the possibility of tapering and rate hikes will actually move markets more than the actual tapering process. Moreover, there is a very strong possibility that the Fed rate hikes will never materialize.
  • Last Friday, gold suddenly dropped about $30/oz for no apparent reason - the reason is apparent now as the Fed has clearly acknowledged that there are upside risks to inflation and it is prepared to contain those risks through a faster tightening of monetary policy than markets had previously anticipated.
  • The gold crash of the last 24 hours is a perfect example of a point I have been making for months - so many gold bugs have been cheering on the inflation data thinking that it was bullish for their precious yellow metal. However, when we are coming off ZIRP and QE4 this reasoning couldn't be more wrong. Market prices are made on the margin, and a threat of Fed tightening in response to too high inflation is USD bullish and precious metals bearish.
  • I have not made it a secret that I am an inflation skeptic, I am also a growth skeptic. I would not be surprised if the tapering timeline gets dragged out past Q2/Q3 2022 and rate hikes do not even materialize during Biden's first term.

From a technical vantage point the damage is extensive and just about the only 'green shoot' for gold is that we have moved all the way back to a layer of important price memory near $1775:

Gold (Daily - One Year)

In the short term gold is extremely oversold after dropping ~$150 in less than one week, and I'm sure there will be plenty of tears and sweeping bearish proclamations made today. For my part I can say that I wish I paid more attention to my own warnings about the unfavorable nature of the month of June, but alas I too got caught up in the rising price trends and the "negative real yields" mumbo jumbo.

Longer term I don't believe that anything has changed, but in the short term a lot has clearly changed. If you are bullish on the economy and believe that inflation is going to run way too hot then you might consider exiting all your precious metals positions. Otherwise, this could prove to be a tremendous buying opportunity (if inflation isn't running too hot, and the labor market isn't as strong as the Fed seems to think), or better yet, an opportunity to take a long weekend. 

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