Yellen’s Testimony and Gold

On Thursday, Janet Yellen testified before the Joint Economic Committee. What can we learn from her testimony?

Fed Chairwoman Janet Yellen is going to raise interest rates in December. She basically reiterated her view on the economy and the future of the Fed policy on Wednesday at the Economic Club of Washington and said that the U.S. had recovered substantially since the Great Recession, and the labor market had tightened. Inflation continues to run low, but Yellen expects it to move up to the FOMC's 2 percent objective over the next few years. Here was the key paragraph:

“That initial rate increase would reflect the Committee’s judgment, based on a range of indicators, that the economy would continue to grow at a pace sufficient to generate further labor market improvement and a return of inflation to 2 percent, even after the reduction in policy accommodation. As I have already noted, I currently judge that U.S. economic growth is likely to be sufficient over the next year or two to result in further improvement in the labor market. Ongoing gains in the labor market, coupled with my judgment that longer-term inflation expectations remain reasonably well anchored, serve to bolster my confidence in a return of inflation to 2 percent as the disinflationary effects of declines in energy and import prices wane.”

Interestingly, she justified a need for a rise citing the lags in the effects of monetary policy and explicitly admitting that the Fed could create excessive risk-taking:

“However, we must also take into account the well-documented lags in the effects of monetary policy. Were the FOMC to delay the start of policy normalization for too long, we would likely end up having to tighten policy relatively abruptly to keep the economy from significantly overshooting both of our goals. Such an abrupt tightening would risk disrupting financial markets and perhaps even inadvertently push the economy into recession. Moreover, holding the federal funds rate at its current level for too long could also encourage excessive risk-taking and thus undermine financial stability.”

Yes, after nearly seven years of zero interest rates, massive asset price inflation all over the world and financial bubbles in emerging markets, the Fed is now concerned about excessive risk-taking. Well, better late than never.

The question-and-answer session indicated that Yellen is quite decided to raise interest rates in December as she decisively downplayed all the reasons to hold rates unchanged cited by the U.S. lawmakers. Other Fed officials also seem to be determined to hike this month. For example, St. Louis Fed President James Bullard said the U.S. central bank should start moving the benchmark lending rate and balance sheet “toward more normal levels.” The new Philadelphia Federal Reserve president Patrick Harker would also prefer hiking sooner rather than later.

The take-home message is that the Fed officials seem to be determined to hike in December. The small raise this month is a foregone conclusion, which should be factored in the gold price. Now, the crucial question for the gold market is the pace of the whole tightening cycle and how the Fed is going to normalize its monetary policy given the huge excess reserves held by commercial banks.

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Arkadiusz Sieron

Sunshine Profits‘ Gold News Monitor and Market Overview Editor