The gold price closed lower by $9.65 to $1,088.10 per ounce as the U.S. dollar rallied and the price of gold declined on speculation that the Federal Reserve is close to beginning the process of normalizing monetary policy. Despite the pledge from the Federal Open Market Committee (FOMC) that interest rates will remain near zero for an “extended period” of time, gold ETFs and gold mining shares reacted negatively to news that the Fed would indeed honor its March deadline for ending its $1.25 trillion quantitative easing program. A hawkish dissent from Kansas City Federal Reserve President Thomas Hoenig with respect to keeping the “extended period of time” language in the Fed’s policy statement fueled speculation that the end of near zero short rates is a 2010 event. Gold mining stocks, as measured by the Market Vectors Gold Mining ETF (GDX), followed the price of gold lower, closing down $0.36 to $42.77.
Governor Hoenig dissented today, stating that “economic and financial conditions had changed sufficiently that the expectation of exceptionally low levels of the federal funds rate for an extended period was no longer warranted.” Moreover, shortly after the release of the Fed’s policy statement, Dow Jones reported that the FOMC could remove the “extended period“ language at its next meeting in March - news that fueled strength in the U.S. Dollar and weakness in the gold price and gold mining stocks.
In spite of President Hoenig’s vote, the policy statement that emanated from the FOMC meeting was very similar to that from its previous meeting in December. Besides once again including the “extended period” language in regards to the time frame for leaving interest rates near zero, Chairman Bernanke and the FOMC also reiterated their view that considerable resource slack will continue to keep inflation subdued for “some time.” In addition, the Fed reiterated the fact that it is gradually concluding the central bank’s $1.25 trillion in purchases of mortgage-backed securities and roughly $175 billion in agency debt - with a deadline set at the end of the first quarter of 2010. One key piece of language did change - the statement that “the pace of economic recovery is likely to be moderate for some time” replaced the previous language stating that the economy will “likely to remain weak for a time.”
In terms of the broader economy’s trend, the FOMC noted that based on information received since the prior meeting in December the economic environment has continued to strengthen while problems in the labor market are subsiding. Household spending is growing at a moderate rate but remains challenged by a weak labor market, modest income growth, lower housing wealth, and tight credit. As for inventory levels, the Fed noted that firms have brought them into better alignment with sales. With respect to bank lending, activity has continued to decline although financial market conditions remain supportive of economic growth.
As a result of this improvement in financial markets, the FOMC confirmed its previously announced plan to withdraw many of its special liquidity facilities on February 1, 2010 - including the Asset-Backed Commercial Paper Money Market Mutual Fund Liquidity Facility, the Commercial Paper Funding Facility, the Primary Dealer Credit Facility, and the Term Securities Lending Facility. The Fed also repeated that the expiration of the Term Asset-Backed Securities Loan Facility - the program providing loans backed by new-issue commercial mortgage-backed securities - remains scheduled to conclude on June 30, 2010 while loans backed by all other types of collateral will expire on March 31, 2010. Lastly the Fed addressed the one special liquidity facility not mentioned in the previous statement - the Term Auction Facility - which is being wound down with $50 billion in 28-day credit to be offered on February 8 and $25 billion in 28-day credit to be offered at the final auction on March 8.
It is clear from the most recent policy statement that the Federal Reserve continues to walk a tightrope between the improved economic data and asset markets and its concerns of the underlying stability of the recovery. The Fed is maintaining its ultra-easy monetary policies to combat deflation while also discounting concerns over the inevitable inflationary consequences of such actions. The Fed has been able to get away with this conundrum by emphasizing potential exit strategies.
In spite of President Hoenig’s dissenting vote and speculation that the end of the Fed’s crisis-driven monetary policy is near, Chairman Bernanke’s continued dovish commentary and the reiteration of the “extended period” of time language in today’s policy statement indicate that the top priority for the Fed remains fighting deflation. Consequently, the macroeconomic landscape remains one that favors those asset classes that benefit from money printing and fiat currency debasement - namely the gold price and gold mining stocks.
