The Fed’s monetary policy statement delivered on Wednesday was the non-surprise/yawn-inducer of the year. Readers can take a look at the trusty WSJ statement tracker, which reveals that apart from a few minor and unimportant changes, the statement was basically a carbon copy of the last one.
Not a single dissent mars this bland exercise in bureaucratese, so there isn’t even anything to report on that front. If you have trouble sleeping, reading this statement might be a very good alternative to Valium.
So did anything noteworthy happen? Well, yes. Apparently market participants believe they have to react to the forecasts of a bunch of bureaucrats who are quite likely among the worst economic forecasters in the world – and that’s really saying something.
Augurs in ancient Rome, observing the behavior of hens.
The High Priests of Augury
It is widely assumed that it is the job of economists to “make predictions”. This is actually not the case. The job of making predictions is that of augurs and soothsayers. In fact, modern-day economists strike us as today’s equivalent of the caste of augurs in ancient Rome.
As Wikipedia informs us:
“The augur was a priest and official in the classical world, especially ancient Rome and Etruria. His main role was the practice of augury, interpreting the will of the gods by studying the flight of birds: whether they are flying in groups or alone, what noises they make as they fly, direction of flight and what kind of birds they are. This was known as “taking the auspices.” The ceremony and function of the augur was central to any major undertaking in Roman society—public or private—including matters of war, commerce, and religion.”
(emphasis added)
Instead of studying the entrails of freshly slaughtered animals or the flight patterns of birds, today’s augurs are poring over statistics in order to “take the auspices” – but the success rate of their predictions is depressingly similar to that of the ancient birdwatchers. If the members of the FOMC board, the high priests of this caste in modern times, were to retire tomorrow and never again utter a forecast, the global economic soothsaying hit rate would likely improve considerably.
It is all the more astonishing that in light of the evidence to date – the chance that an economic forecast by the Fed actually pans out is approximately 0.0% (give or take a zero behind the decimal point) – market participants are actually paying attention to nonsense like the infamous “dot plot”.
The bizarre “dot plot” which indicates the estimates of FOMC members regarding the “future path of monetary policy”. Might as well throw darts, click to enlarge.
The Fed is actually not really “planning” anything – it is just reacting, mainly to data that have become meaningless by the time it reacts, as they simply describe the past. It is an organization that is driving forward with its eyes firmly fixed on the rear-view mirror. Meanwhile, any estimates of future economic trends provided by its members have historically proved to be an exercise in futility. Charts like the one above aren’t revealing any earth-shattering insights.
This brings us to the market reaction to the FOMC statement. So far we have seen both immediate and delayed reactions, which seemed largely based on the dots on the above “dot plot” dropping a bit compared to last time. These reactions have included a sharp pullback in the US dollar, a noteworthy jump in the gold price, and quelle surprise, a sizable rally in the stock market. Evidently the idea is that the most extensively pre-announced rate hike in all of history might be postponed even further.
This is quite funny, because it should make little to no difference to the economy whether or not the Federal Funds target rate corridor is set a handful of basis points higher. It might make a difference to a few carry trades, but any dollar carry trades that existed (using the dollar as a funding currency) have likely been blown out of the water long ago.
Does it Make Sense to Buy Gold Based on Dot Plot Fluctuations?
A 20 minute candlestick chart of the August gold contract over the past three trading days click to enlarge.
As you can see above, traders have apparently also bought gold based on the premise that a Fed rate hike might happen somewhat later. It should be noted that gold was actually quite oversold going into the FOMC meeting, so it may well have bounced no matter what. Assuming though that the “dot plot” was the trigger, the question is: Does this make any sense?
Apart from the fact that the “dot plot” has actually no predictive value, there are other grounds for believing that this reasoning may be flawed. Don’t get us wrong – we have nothing against gold going higher. We believe its current price doesn’t adequately reflect extant systemic risk, although we must also concede that the current fundamental backdrop isn’t unequivocally bullish (as to why, see our list of fundamental drivers of the gold price). However, it appears that there is enough “insurance buying” of gold combined with fairly strong reservation demand from current gold holders to lend strong support to the price near current levels.
Normally rising interest rates are bearish for gold, ceteris paribus (if nominal rates were to rise, while inflation expectations rise even faster, the ceteris would of course no longer be paribus). The low interest rate backdrop and the still brisk growth rate of the US money supply (and the even brisker growth rate of the euro area money supply), which would normally be bullish for gold, are currently mainly supportive of the bubble in assorted risk assets. As long as the bubble in risk continues to expand, market participants won’t have much interest in gold.
As a result of this, gold bulls should probably root for a rate hike. In the very short term, the gold market would likely react negatively to a rate hike. But the gold market traditionally has a tendency to be extremely forward looking. This is probably why gold didn’t rally when “QE3” was launched (apart from losing its euro area crisis premium). Gold market participants intuited correctly that QE3 would be followed by a tightening of monetary policy, which has indeed happened via “tapering” and the cessation of QE3. Any move by the Fed that endangers the bubble in risk should therefore be bullish for gold. The gold market would soon look beyond the tightening of monetary policy and begin to discount its inevitable loosening in the future.
A rate hike delay might turn out to be unequivocally bullish for gold if it eventually becomes apparent that there will never be a rate hike, i.e., if the QE spigot is reopened without an intervening rate hike. This possibility cannot be dismissed out of hand, in spite of Mrs. Yellen’s seeming determination to get at least one rate hike in before the year ends. We cannot dismiss it, because we don’t know what exactly will prick the bubble. Eventually there will be a reversal of the credit expansion-induced distortions in relative prices in the economy and a bust will begin. While this normally requires rising rates and a sharp slowdown in money supply growth, the current situation is highly unusual and things may not play out in line with the traditional script.
Conclusion
Government intervention in the economy is actually the main reason why economists are bothering to make predictions about a multitude of statistics nowadays. Most of their usually quite inaccurate macro-economic forecasts would be of little use in an unhampered market economy, and their market value would accordingly be very low. Given its record, it seems especially odd that people are taking actions in the markets based on the forecasts released by the FOMC.
With respect to the gold market, what is actually medium to long term bullish or bearish is often not as obvious as is generally believed. One must keep in mind that the gold market tends to discount future developments far in advance; because of this, superficially bullish or bearish developments may ultimately turn out to have a different effect than expected.
Charts by: Federal Reserve board, BarChart
