This week the Federal Reserve pre-announced an upcoming slowing in its enormous quantitative-easing money-printing campaign. That QE-tapering warning was widely expected on Wall Street, so it wasn’t a market-moving surprise. Gold is particularly sensitive to Fed policy changes, because of hyper-leveraged gold-futures trading. Expected Fed tightening often triggers selling there, because the US dollar rallies.
The Fed’s Federal Open Market Committee met Wednesday in one of its eight meetings per year. Most of those are uneventful, with no monetary-policy changes. Gradualism is the Fed’s mantra, as moving fast or surprising can really impact markets. This week’s FOMC statement unanimously approved by top Fed officials had a new sentence added, a formal notice that this central bank will soon start slowing QE.
It read “If progress continues broadly as expected, the Committee judges that a moderation in the pace of asset purchases may soon be warranted.” That’s pretty vague, as “soon” is subjective with no timeline. Gold initially rallied smartly from $1,776 to $1,787 on the FOMC apparently punting on locking down QE tapering. The US dollar’s leading benchmark, the US Dollar Index, also slumped on that lack of specifics.
Gold’s first reaction was impressive considering this was one of the every-other FOMC meetings that are accompanied by top Fed officials’ individual economic outlooks. Those include where these 18 governors and regional presidents expect their directly-controlled federal-funds rate to be in coming years. Called the dot plot due to its presentation, that proved hawkish with potential rate hikes pulled forward one year.
In the previous dot plot from mid-June, just a third of Fed officials expected to maybe see two quarter-point rate hikes way out into year-end 2023. Even that mere hint of distant-future rate hikes slammed gold, interrupting a strong young upleg. In three trading days starting that Fed Day, the yellow metal plunged 5.2% on extreme gold-futures selling. That was ignited by a powerful 1.9% USDX surge over that same span.
The 2022 rate-hike outlook then was none, as a majority 11 out of 18 officials expected their zero-interest-rate policy to continue prevailing next year. That shifted slightly this week, with only 9 of 18 seeing ZIRP persisting in 2022. 6 saw a quarter-point hike at some point while 3 expect two hikes. Those tallies rose from 5 and 2 at the mid-June meeting. So the first quarter-point hike is now implied by the end of next year.
These dot plots are notoriously-inaccurate forecasters of future federal-funds-rate levels. The Fed chair himself explicitly warned about that in his mid-June post-FOMC-meeting press conference. Examples are legion. The Fed’s last rate-hike cycle started in mid-December 2015. That day the FOMC hiked the first time, the dots predicted four more rate hikes in 2016. But only a single one came a year later in December.
The December-2018 dot plot came on the day the FOMC hiked for the ninth time in that tightening cycle. That day’s dots forecast three more hikes in 2019 and 2020. Yet none of those came to pass, the Fed was done hiking! So seeing the USDX and gold trade in the wake of the quarterly FOMC meetings that include dot plots is super-irrational. Those individual rate outlooks aren’t authoritative and are usually wrong.
But this week’s dot-plot omen of a potential rate hike by year-end 2022 was certainly hawkish, making gold’s post-FOMC surge look all the more impressive. In last week’s essay, I laid out a case arguing gold’s latest “taper tantrum” fueled by heavy-to-extreme gold-futures selling had largely already happened in slow motion in anticipation of the Fed announcement. Gold-futures speculators’ capital firepower is limited.
The real surprise at this week’s FOMC meeting was Jerome Powell’s press conference. Since they can move markets, I watch all of them live. This Fed chair was as hawkish as I’ve ever heard him! Reporters naturally asked Powell about the QE-taper timeline. He was very clear, bordering on emphatic, that actual QE tapering would likely be announced at the FOMC’s next meeting. That is coming on November 3rd!
Powell was also asked if a bad monthly US jobs report in early October would change his mind on getting tapering underway. He said no, that the economic-data trends were more important than any individual print. He even declared the Fed’s colossal $120b-per-month QE money printing would likely be done by the middle of next year. Powell sounded like that timeline was firm unless some catastrophe happens.
Wall Street Fed-whisperers universally concluded all this means the formal QE-tapering announcement is happening in early November at the FOMC’s next meeting. They think the Fed will then actually start slowing its bond buying in December. The consensus guess is that tapering will happen at a $15b-per-month or maybe $15b-per-FOMC-meeting pace. The former means fully ending $120b of QE will take 8 months.
$15b tapering is logical because that $120b of monthly QE is split into $80b of Treasury monetizations and $40b of mortgage-backed securities. $15b fits into that well, allocating $10b of monthly tapering to Treasuries and $5b to MBSs. If that timeline holds, there will be another $120b of QE in November and a further $420b during tapering from December to June. So at least $540b of more QE is still coming!
Since Powell’s role in his post-FOMC press conferences is to talk more dovish than the already-dovish FOMC statements, traders reacted to his QE-tapering resoluteness. The USDX caught a sizable bid, so gold reversed sharply to plunge from $1,785 to $1,766. But this metal still ended that Fed Day with a minor 0.4% loss, far better than mid-June’s 1.6% on that previous hawkish dot plot. Gold was holding its own.
Gold rallied overnight into Thursday, clawing back up near $1,775. But during the US session that day as I penned this, gold was hammered sharply lower by what had to be heavy gold-futures selling. Over an hour-and-a-half, gold plunged from $1,770 to $1,750. Very oddly that was despite the US Dollar Index falling a major 0.5% by midday! Gold-futures speculators fleeing again given this backdrop was highly irrational.
Fed money printing, the root of all inflation, is very bullish for gold. This metal’s mined supply only grows on the order of 1% annually. So when the Fed ramps US dollars considerably faster, relatively more of them flood the system and can bid up relatively-less gold faster. If the FOMC actually holds to that QE-tapering timeline Powell implied, again another $540b of money printing is still coming in QE4’s epic campaign.
That’s big alone, a larger fraction of QE1’s total $1,750b, QE2’s $900b, or QE3’s $1,590b. The FOMC effectively announced more QE is still coming that is a third as large as QE3! Gold ought to have rallied sharply on that. Another $540b of QE in the pipeline is even sizable in the context of the epic QE4 bond monetizations. They started in October 2019, accelerating after March 2020’s pandemic-lockdown stock panic.
QE4 has proven mind-bogglingly large, with the Fed’s balance sheet skyrocketing 124.7% or $4,689b over the past 24.6 months! Fully 7/8ths of that came since Fed officials panicked as stock markets plummeted early last year. In the last 18.2 months since March 2020, this profligate Fed mushroomed the US-dollar supply by a jaw-dropping 95.9% or $4,137b! Another $540b during tapering adds another 1/8th.
And the critical thing about QE tapering is it only shuts off the monetary firehoses, it is a far cry from starting to reverse these radically-unprecedented monetary excesses through quantitative tightening. The Fed tried QT years after QE3 in 2018 and 2019, but cried uncle once that monetary destruction started weighing heavily on stock markets. The S&P 500 plunged 19.8% in just 3.1 months in Q4’18, scaring Fed officials.
QT along with the ninth rate hike in the last hiking cycle were increasingly blamed, and Fed officials did not want to risk spawning a negative-wealth-effect-induced recession. I analyzed the Fed’s risky QE4 stock ramp in January 2020, after arguing in late 2018 that Fed QT would prove that stock bull’s death knell. The FOMC’s stomach for tightening fades fast as stock markets crumble into major selloffs fueled by it.
So if stock markets hold up through this QE4 tapering into summer 2022, the Fed’s balance sheet will grow from its current $8.4t right up near $9.0t! Before the FOMC frantically started QE4 within a couple months of prematurely killing QT, that balance sheet ran just $3.8t. Mere QE tapering keeps those vast deluges of new dollars in place, a super-inflationary environment of monetary excess very bullish for gold.
And this upcoming QE4 tapering may not even fully happen. The FOMC will pull the plug fast if US stock markets again plunge into major-correction territory nearing a 20% S&P 500 loss or exceed that to enter formal bear-market territory. As I explored more in last week’s essay, today’s extreme bubble valuations in US stock markets fueled by the Fed’s epic money printing make them very vulnerable to serious losses.
The political pressure on the Fed to keep redlining its monetary printing presses is intense too. QE4 is again monetizing $80b per month of US Treasuries, or $960b per year! Without the Fed remaining the biggest buyer of US debt, who will finance Washington’s crazy deficit spending? The Fed withdrawing from buying Treasuries will force longer interest rates much higher. That will infuriate the ruling Democrats.
While they control both chambers of Congress, their majorities are razor-thin. So the November 2022 midterm elections are crucial to both political parties. The president of the United States directly appoints the Fed governors, who fully control FOMC voting. Of its 11 voting members, fully 7 are always these political appointees. The regional-Fed presidents are just figureheads, only having 4 votes on a rotating basis.
So if the Democrats ram through their colossal spending plans to help bribe voters ahead of the midterm elections next year, can they afford Fed QE slowing to zero? If not, they could pressure Fed governors to resign so Biden can appoint socialist inflationists subscribing to Modern Monetary Theory. Interestingly Jerome Powell’s own four-year term as chair expires in early February 2022, so he could be easily replaced.
With fragile Fed-QE-levitated bubble-valued stock markets and hyper-partisan politics, I’d be surprised if we get to next summer and the Fed actually transitions out of QE-money-printing mode. The FOMC has a long history of folding on tightening when stock markets fall or political pressure mounts. But even if this QE4 tapering indeed happens as planned, that’s no justification for the USDX to rally and gold to fall.
This chart superimposes gold in red over the US Dollar Index in blue during recent years. Yes, gold and the USDX are often inversely correlated due to the extreme leverage inherent in gold-futures trading. But that is not always true. Gold can still rally on balance when the dollar is strengthening. And since the Fed won’t touch QT with a ten-foot pole and actually start unwinding its crazy money printing, the dollar should weaken.
The US Dollar Index has been marching higher on balance throughout 2021. It was extremely oversold entering this year after heavily-crowded dollar short selling. Plenty of major gold peaks and troughs since its last mighty upleg crested in August 2020 have coincided with opposing major lows and highs in the USDX. Gold-futures speculators are quick to sell when the dollar rallies, often on Fed-tightening expectations.
This Wednesday during that FOMC meeting, each 100-ounce gold-futures contract controlled $176,700 worth of gold. Yet gold-futures speculators were only required to keep cash margin in their accounts of $8,250 per contract. That implies maximum leverage of 21.4x, which is actually not even particularly high for gold futures. At 21x, every 1% gold moves drives huge 21% gains or losses in fully-leveraged gold futures.
A mere 4.7% gold move against these traders’ bets would wipe out fully 100% of their capital risked! So they can’t afford to be wrong for long. These extreme risks necessitate an ultra-myopic short-term focus, all they can care about is hours or maybe days. So they are quick to sell when the USDX rallies, which often happens when traders perceive the Fed being more likely to tighten. Several episodes recently happened.
After that mid-June dot plot showing maybe two rate hikes into year-end 2023, gold-futures speculators fled on the sharply-higher US dollar hammering gold sharply lower. That interrupted this metal’s solid young upleg. Then in early August a better-than-expected monthly-US-jobs report upped the odds of the Fed starting tapering QE soon. That unleashed extreme gold-futures selling culminating in a shorting attack.
Then last week a big upside surprise in US retail sales unleashed another bout of outsized gold-futures selling on a USDX surge. Gold has only suffered several big-and-sharp selloffs since mid-June, and it is still trending higher on balance. That’s despite the USDX continuing to do the same! Big gold-futures selling on Fed-tightening-expectations-driven dollar surges is usually short-lived, exhausting within a few days.
Those several episodes of heavy-to-extreme gold-futures selling have likely already expended the great majority of potential selling on the Fed’s QE tapering. Again I analyzed that in depth in last week’s essay on the gold taper tantrum mostly already unfolding in slow motion. Despite their leverage enabling them to punch weigh above their weights in moving gold, gold-futures speculators’ capital firepower is very finite.
And realistically how high is the USDX likely to climb on the mere slowing of the Fed’s colossal money-supply growth? This leading dollar benchmark has hit major resistance around 93 several times so far in 2021 including this week. So far this year the USDX has averaged about 91.5. Dollar bulls abound, with plenty arguing that the USDX should mean revert back to 2019 levels where it averaged a much-higher 97.4.
That seems one heck of an optimistic stretch though, especially if Fed monetary policy is really a major driver of the dollar’s fortunes. This year the federal funds rate is going to average sub-0.1%, ZIRP reigns. Not only does the US dollar have no nominal yield, but its real yield is deeply negative due to the colossal headline inflation the Fed’s radical money printing has unleashed. ZIRP will prevail for almost all of 2022 too.
In 2019 pre-pandemic-monetary-deluge when the USDX was much higher, the federal funds rate was also way higher averaging almost 2.2%! And real yields then were slightly positive with much lower inflation. There were also far fewer dollars in existence in 2019, making them more valuable. That year the Fed’s balance sheet averaged $3,931b. So far in 2021 it has literally doubled that averaging $7,879b!
With vastly more dollars now than in 2019, and nominal and real yields way lower and negative, why on earth should the USDX rally on the Fed just slowing its money-supply growth? Far more logical would be for the wildly-oversupplied US dollar to reverse lower to resume its 2020 downtrend and plumb fresh new depths. While actual Fed QT or a new rate-hike cycle would be dollar-bullish, they aren’t on the table today.
So I’d argue this year’s US-dollar upside on Fed tightening has likely already mostly run its course. The Fed’s balance sheet will continue surging into mid-2022, and that’s if the FOMC actually carries through on fully tapering QE4. The Fed isn’t even tightening at least until the end of next year, it is just slowing the pace of easing. This remains very dollar-bearish fundamentally, which of course is great news for gold.
The gold-futures speculators fleeing in response to sharp USDX rallies on perceived Fed tightening has probably already largely exhausted their selling potential. They need to normalize their excessively-bearish bets, which means big buying that will catapult gold much higher. The gold miners’ stocks will be the main beneficiaries of gold recovering, as they tend to leverage their metal’s upside by at least 2x to 3x.
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The bottom line is the Fed tapering QE4 isn’t bearish for gold at all. Slowing extreme money printing is a far cry from actual Fed tightening. The FOMC isn’t even considering unwinding QE monetary excesses through QT or launching a new rate-hike cycle. Even if the Fed carries through on QE tapering, money-supply growth will remain fast into the middle of next year. And the FOMC’s tapering plans could be derailed.
A big stock-market selloff or intense political pressure to monetize Democrats’ huge deficit spending could easily prematurely slay tapering. Whether the Fed actually finishes it or not, the dollar’s deep sub-zero real yields and recent doubling of its supply remain very bearish for this currency. So fundamentally a weaker US dollar is much more likely than a stronger one. And that would really boost gold demand and prices.
Adam Hamilton, CPA
September 24, 2021
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