US Federal Reserve Policy Meeting

The US Federal Reserve begins its once-per-six-weeks policy meeting on Tuesday. 

Chairwoman Janet Yellen will issue a statement on Wednesday at 2 pm EST. Expect lower volatility across most markets on Tuesday and Wednesday before the announcement.

Additionally, watch for a spike in volatility immediately after 2 pm. 

We cannot know what they will announce. However, the charts are positioning themselves for an essential low to form.

This will be across the precious metals complex coming into the Fed meeting. The markets are pricing in a near-zero chance of an interest rate hike on Wednesday.

Roughly, there is a 50% chance for a hike at the last meeting of the year in December. Below we show the current dot-plot.

This is for interest rate expectations by the 16 members of the Federal Open Market Committee (FOMC). This gives a consensus estimate for what US short-term interest rates will average for each of the next two years and beyond. For 2018, the consensus average is 2.00% – 2.25%.

This will necessitate four more quarter-point interest rate hikes from the current target of 1.00% - 1.25%. Which is the general expectation of the FOMC, although it is always subject to change based on market conditions.

The Fed

There is expected to be no rate hike this Wednesday.

However, the markets will be watching for a potentially more important source of information. That is, language describing the Fed’s intentions to “normalize” its balance sheet going forward.

The Fed is set to normalize its balance sheet. This first went into the discussion at the policy meeting in June. However, we have no tangible information as to how or when the Fed intends to engage in this normalization.

As a reminder, gold tends to sell off strongly on the day that the Fed announces its balance sheet normalization intentions. Which will be at the June 14 meeting.

“Normalization” – Say What?

Normalization is a euphemism used by central banks including the Fed. The term is used to describe the selling of bonds and other securities that the Fed has “purchased.”

These purchases are since the credit crisis of 2007 – 2009. Recall that these bonds – and all assets the Fed ever buys – are purchased with freshly created electronic money.

Whenever the Fed mentions purchasing anything, it is universally talking about printing money and debasing the currency. In other words, creating inflation.

Mainstream financial publications rarely mention this.

The reality of the situation would be too appalling to discuss in such a forthcoming manner.

Manipulating the prices of assets by purchasing them with newly-created money. This is the only tool that the Fed has ever had.

Let's discuss a reminder of the unprecedented nature of the Fed’s balance sheet. The following chart is a reprint courtesy of the Wall Street Journal. It shows the Fed’s holdings from 2004 through the present: The most important point to observe is this.

The Fed, from its creation in 1913 through 2008, went to accumulate (a.k.a. print) $1 trillion in assets. Yet, in just the last nine years alone it has printed over $3 trillion.

The Fed's balance sheet has grown from $1 trillion to over $4 trillion.

A second key to recall is that the bulk of the Fed’s purchases have gone toward US treasuries and US mortgages. Is it any wonder that long-term bond and mortgage rates are the lowest they have been since World War II? The Fed completely distorts the very fabric of the financial marketplace.

The Fed will affect every piece of the system that sits on top of this distortion base. This is especially true if the Fed begins to normalize its balance sheet.

US Treasury – annual interest expense

Now consider-- this near-record interest expense is accumulating when benchmark 10-year Treasury bonds are at their lowest rates in over two generations:   In other words, the government is paying record-high interest when rates are at their lowest in modern history.

Can we imagine if treasury rates simply double? Or, go back to longer-term averages near 5.0%? Such would mean that the US government’s interest expense would approach $1 trillion per year.

This is assuming no further debt adds to the equation. And of course, new debt keeps being adding to the pile each year.

What if 10-year yields returned to 7.5%? They just average for nearly 25 years from 1970 – 1995.

The Fed states that it intends to normalize its balance sheet. However, it is saying that it plans to sell its recently-purchased treasury bonds. Thus, they will allow interest rates to rise.

Can the Fed realistically be expected to sell much of its balance sheet? This will be in the face of record US interest expense. Thus forcing the government to roll over its debt at higher and higher rates? The practical answer is: no.

Most Only Know Falling Rates

Let us observe this. Anyone who has been investing in the western world since 1980 knows falling interest rates as a macroeconomic backdrop. Let's assume the average investor begins his or her career at age 22.

This means that anyone born after 1958 knows only that interest rates keep falling, year after year. A reversal in 37 years of falling interest rates is what the Fed is proposing. We believe the Fed has backed itself into a corner. It will have to renege on its normalization-speak.

If the Fed allows interest rates to rise significantly, the central bank will crush the funding mechanism of the US government. If it continues to suppress rates through newly-created money, it will begin to lose credibility as an independent and impartial body.

The Fed risks a loss of confidence in the very institution of central banking in the United States As well as likely spreading around the western world. Such will not happen overnight. Yet, the Fed is walking a tight line between its credibility and the ability of the United States government to fund its operations.

A Third Central Bank Failure?

Let us not forget: two central banks have already failed in the United States. The United States went to dissolve the first bank in 1811.

The Second Bank of the United States did not receive a charter renewal in 1836. Central banking was not present nor required in the United States during the great technological revolutions of the mid-1800s through the early 1900s. This was including the implementation of the railroad; the light bulb; the telephone; radio, automobile; and air travel.

Could we see the first warning signs that a third central bank has caught itself in an unsolvable situation? Will it follow a similar fate as the first two?

There is an era of faltering faith in central-bank promises. Gold stands to assume its historical function as the premier asset class of last resort. It is the only financial asset with no counterparty risk. Furthermore, it is no one's liability. The history books have yet to write about it.

However, fundamental data points with the plight of the Fed are there in plain sight for all to see. For now, we watch to observe how the Fed handles its intentions for normalizing its balance sheet. We will see at this Wednesday’s meeting, and through the remainder of this year.  

Christopher Aaron, Bullion Exchanges Market Analyst

Christopher Aaron has been trading in the commodity and financial markets since the early 2000s. He began his career as an intelligence analyst for the Central Intelligence Agency. This is where he specialized in the creation and interpretation of pattern-of-life mapping in Afghanistan and Iraq.

Technical analysis shares many similarities with mapping. They both base on the observations of repeating and embedded patterns in human nature. His strategy of blending behavioral and technical analysis has helped him and his clients. It helps to identify both long-term market cycles and short-term opportunities for profit.

This article is a third-party analysis. It does not necessarily match the views of Bullion Exchanges. Readers should not consider it as financial advice in any way.