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Fed Panics over Coronavirus. What’s Next for Gold?

Commodities / Gold & Silver 2020 Mar 06, 2020 - 11:54 AM GMT

By: Arkadiusz_Sieron

Commodities

Yesterday, the Fed cut interest rates by 50 basis points. Not during a regular monetary policy meeting, but in a surprising move. But what are the implications for the gold market specifically?

Fed Cuts Interest Rates in Emergency Move

Last week, I wrote that the spread of the new coronavirus to Europe and the inversion of the yield curve make “the Fed more likely to step in and cut the federal funds rate, you know, “just in case”. And in yesterday’s surprise move, the Federal Reserve cut the federal funds rate by 50 basis points in response to the coronavirus threat. The decision was unanimous and it was communicated in the FOMC statement as follows:


The fundamentals of the US economy remain strong. However, the coronavirus poses evolving risks to economic activity. In light of these risks and in support of achieving its maximum employment and price stability goals, the Federal Open Market Committee decided today to lower the target range for the federal funds rate by 1/2 percentage point, to 1 to 1 1/4 percent. The Committee is closely monitoring developments and their implications for the economic outlook and will use its tools and act as appropriate to support the economy.

Without doubts, the move is huge. First of all, the US central bank cut interest rates not by 25 basis points, as usual, but by half a percentage point. It was the first such cut since the Great Recession. And the FOMC slashed the federal funds rate before its scheduled meeting on March 17-18, which is a very rare move. Taking monetary policy decisions between regular meetings with a bigger than normal interest rate cut, implies that the Fed is scared as hell.

Or that the US central bank was simply told to slash interest rates. Maybe not coincidently, the move came the same morning that G7 officials offered unspecified measures to help impacted countries. And President Trump has been tweeting intensively in recent days, pressuring the Fed to act. In yesterday’s morning, he wrote:

Australia’s Central Bank cut interest rates and stated it will most likely further ease in order to make up for China’s coronavirus situation and slowdown...Other countries are doing the same thing, if not more so. Our Federal Reserve has us paying higher rates than many others, when we should be paying less.

Fed’s Cut and the Economy

Will the Fed’s dovish action help to contain the virus? To ask such a question is to answer it. Will the Fed’s panic move fix the broken global supply chains? Another rhetorical question. The monetary policy is powerless when faced with supply problems. When you cannot get the necessary inputs from Asia for your factory, whether the interest rates are 50 basis points higher or lower is irrelevant for you. So, the Fed’s move is unnecessary and it will not help the global economy with the impaired supply chains.

What the Fed can do, is to trigger panic in the markets. Initially, the stock market welcomed the news. But later it turned sharply lower. It suggests that the Fed’s panic move made traders feel more nervous about the coronavirus and its impact on the economy. Indeed, the CBOE Volatility Index has returned to nine-year highs after the move. After all, the Fed officials were talking all the time that they were monitoring the situation, that everything is fine, and then, boom, a surprise cut by 50 basis points! So investors could think “if they act like this, the situation must be worse than we thought”. Powell justified the move by the material reassessment: he said during the press conference that “the coronavirus poses a material risk to the economic outlook”.

Yeah, he suddenly realized it! For me, it looks like a panic response to the plunge in the stock market (Fed’s put is always is place!) and to the inversion in the yield curve. As you can see in the chart below, the 10-year Treasury yield has dropped to a record-low of 1.1 percent yesterday and later (not visible on the chart) even below 1.0 percent.

Chart 1: US 10-year Treasury yield from March 2019 to March 2020.

Implications for Gold

What does it all mean for the gold market? Well, from the fundamental point of view, the environment of fear, ultra low interest rates, weak equity markets and elevated stock market volatility should be positive for the yellow metal.

It’s true that gold saw a major sell-off last week. However, its price jumped again to $1,640-$1,650 in a response to the Fed’s move. The scale of a move might seem to be a bit disappointing, so investors should be aware of a possibility of further downside, as the precious metal will continue to feel some pressure from investors’ liquidity needs. However, it might be just a replay of 2008, when gold was initially dumped in order to meet investors’ margin calls only to rally later. The good news is that the markets expect further Fed’s interest rate cuts on the way – it lays the foundation for future gains in the gold market.

If you enjoyed the above analysis and would you like to know more about the gold ETFs and their impact on gold price, we invite you to read the April Market Overview report. If you're interested in the detailed price analysis and price projections with targets, we invite you to sign up for our Gold & Silver Trading Alerts . If you're not ready to subscribe at this time, we invite you to sign up for our gold newsletter and stay up-to-date with our latest free articles. It's free and you can unsubscribe anytime.

Arkadiusz Sieron
Sunshine Profits‘ Market Overview Editor

Disclaimer

All essays, research and information found above represent analyses and opinions of Przemyslaw Radomski, CFA and Sunshine Profits' associates only. As such, it may prove wrong and be a subject to change without notice. Opinions and analyses were based on data available to authors of respective essays at the time of writing. Although the information provided above is based on careful research and sources that are believed to be accurate, Przemyslaw Radomski, CFA and his associates do not guarantee the accuracy or thoroughness of the data or information reported. The opinions published above are neither an offer nor a recommendation to purchase or sell any securities. Mr. Radomski is not a Registered Securities Advisor. By reading Przemyslaw Radomski's, CFA reports you fully agree that he will not be held responsible or liable for any decisions you make regarding any information provided in these reports. Investing, trading and speculation in any financial markets may involve high risk of loss. Przemyslaw Radomski, CFA, Sunshine Profits' employees and affiliates as well as members of their families may have a short or long position in any securities, including those mentioned in any of the reports or essays, and may make additional purchases and/or sales of those securities without notice.

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