Three Key Takeaways from December 2017 FOMC Minutes for Gold / Commodities / Gold and Silver 2018

Yesterday, the minutes ofthe FOMC December meeting were released. What do they sayabout the Fed’s stance and what do they mean for the gold market?

The Fed IsDivided over Number of Hikes in 2018

At the December meeting, the U.S. central bank increased the federal funds rate by a quarter percentage point to a range 1.25-1.50 percent. The move was widely expected by investors, but there was no unanimity at the meeting as two FOMC members dissented. The Fed officials were also divided over the forecast of three rate hikes in 2018. The hawks noted that more hikes would be appropriate as financial conditions had not tightened since the Fed started raising rates at the end of 2015. On the other hand, the doves pointed out that too aggressive hiking might prevent a sustained return of inflation:

A fewparticipants indicated that they were not comfortable with the degree ofadditional policy tightening through the end of 2018 implied by the medianprojections for the federal funds rate in the December SEP. They expressedconcern that such a path of increases in the policy rate, while gradual, mightprove inconsistent with a sustained return of inflation to 2 percent, or thatthe level of the federal funds rate might already be near its current neutralvalue. A few other participants mentioned that they saw as appropriate a paceof additional policy tightening through the end of 2018 that was somewhatfaster than that implied by the December SEP median forecast. They noted thatfinancial conditions had not materially tightened since the removal of monetarypolicy accommodation began, that continued low interest rates risked financialinstability in the future, or that the labor market was increasingly tight.

However, the division will soften in 2018. TheCommittee will be more hawkish in 2018. Why? The biggest doves who dissented atthe last meeting, Neel Kashari and Charles Evans, are not voting members in2018. What does it mean? The risks to the forecast of three rate hikes are notbalanced, but biased upwards. Currently, investors accept the forecast, with the marketodds of a March hike at about 68 percent. If theexpectations turn to be more hawkish over the year, gold may be under pressure. You have been warned.

Fed Doesn’tBelieve in Huge Effects of Tax Reform

The last minutes showed that the FOMC members expectthat the Republican tax plan will have only a modest impact on the economy. Theyrevised up their forecast for real GDP growth beyond 2017, as the changes inthe tax code would likely provide a modest boost to consumer and capitalspending.

Beyond 2017,the forecast for real GDP growth was revised up modestly, reflecting thestaff's updated assumption that the reduction in federal income taxes expectedto begin next year would be larger than assumed in the previous projection. Thestaff projected that real GDP would increase at a modestly faster pace thanpotential output through 2019.

However, the Fed officials stated that the magnitudeof the effects was uncertain, as companies could use the increase in cash flowfor debt reduction or stock buybacks. Only time will tell the exact effects –we expect that the tax reform will benefit the U.S. economy, which is not good news for the gold prices.The near-term benefits are rather priced in the market, but investors haven’ttaken all longer-term benefits into account yet. Remember. As the reform givescompanies incentives to build plantsin the United States ratherthan overseas, we are likely to see an increase in capital spending.

No Agreementon Inflation Outlook?

The debate about the path of rates was closely linkedto the inflation outlook. The doves believe that the low inflation could remainsoft. However, they were in the minority, as the FOMC members generally viewedthe medium-term outlook for inflation as little changed. The majority of themcontinued to “expect inflation to gradually return to the Committee’s 2 percentlonger-run objective.”

Indeed, “the staff projected that inflation would bevery close to the Committee's 2 percent objective in 2019 and at that objectivein 2020.” And “the risks to the projection for inflation also were seen asbalanced.”

So much for low inflation as the reason for a more dovishFed in the near future. The opposite is actually more probable, given all thepersonal changes in the composition of the FOMC.

Conclusion

The minutes from the latest FOMC meeting were ratherhawkish. The U.S. dollar increased in a response, while the price of golddeclined, as one can see in the chart below.

Chart 1: Gold prices over the last three days.

The FOMC members are still seeking a gradual rise inthe U.S. interest rates, despite the internal division over the subduedinflation. In 2018, the biggest skeptics in such approach won’t vote, so weexpect a more hawkish Fed. It should be a tailwind for gold. However, the firstmeeting with the new composition will tell us more. Stay tuned!

Thank you.

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Arkadiusz Sieron
Sunshine Profits‘ MarketOverview Editor

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