If it does not go up on good news…

After the release of the US labor market data the week before, there was no major data release scheduled for the week just ending. Thus, it were only speeches and statements by FOMC members, which had an impact on the markets. However, despite a slightly weaker US dollar, a firmer US stock market and yields on 10yr US Treasury notes edging down, the precious markets showed a disappointing performance. Only gold ended slightly in the plus, while silver and palladium posted stronger losses.

At the beginning of the week, it was the president of the Federal Reserve Bank of Atlanta, David Lockhart, who confused the markets somewhat. While pointing out that the FOMC could decide as early as at the forthcoming meeting in December to taper the bond purchases, he also argued for postponing the decision. However, Mr. Lockhart is currently not a voting member of the FOMC. He only pointed out that there is a possibility for a tapering decision next month. But the likelihood for this decision being made is rather small. As he provided arguments for delaying tapering further into next year, which were supported by another regional Fed president, there appears to be currently no majority for tapering within the FOMC. The negative reaction to mentioning just the possibility of deciding to taper in December demonstrates how irrational financial and commodity markets sometimes react.

Various empirical studies point to a high drug abuse in financial centers. And many traders and investors must have been on drugs to fear that Janet Yellen might suddenly change her mind during the Senate hearing for her appointment as first Fed chairwoman following Ben Bernanke in February next year. Mrs. Yellen is one of the architects of the current quantitative easing and the forward guidance provided by the FOMC. She always voted in line with Mr. Bernanke. Thus, it was irrational to fear that she would indicate that under her presidency the Fed would make an abrupt shift in monetary policy. She stands for continuity in the Fed policy. But only after the release of her written statement to the Senate, the markets got more relaxed and stock markets reached new record highs for the Dow and S&P 500 index. However, the precious metals could not benefit from this development.

This week, the World Gold Council released its quarterly report on Gold Demand Trends for Q3. The demand for bars and coins declined from 531.3 tons in Q2 to 304.2 tons. The dis-investment in ETFs continued albeit at a slower pace by -118.7 tons after -402.2 tons in the preceding quarter. Thus, it was not only “paper gold” but also physical gold demand, which disappointed. Nevertheless, total net demand of this two major groups increased by 43.7% from 129.1 to 185.5 tons in the third quarter. But this was not enough to push the price of gold above technical resistance.

That dis-investment in gold ETFs continued was already quite obvious by following the gold holdings of the SPDR Gold Trust ETF. However, one could only speculate who was the driving force behind the selling. As John Paulson’s hedge funds are a major stake holder and have suffered huge losses, they appeared as a potential candidate liquidating holdings to fund redemptions to disappointed investors. However, the recent SEC data surprised by showing that Mr. Paulson kept his stake nearly unchanged. It were other big investors who reduced their stake considerably. Especially PIMCO was mentioned in reports. The so-called king of bonds Bill Gross got some trends in fixed income markets wrong this year. Thus, PIMCO and in particular its flagship total return bond funds suffered massive outflows for several months in a row. Therefore, our speculation that liquidation of positions to meet fund withdrawals from investors was right, but it was just another whale. Nevertheless, big funds could drive a market rapidly higher but if they liquidate positions, the drop might be far steeper.

 For several weeks, the CFTC report on the “Commitment of Traders” was not available. Not only had the delayed releases showed some surprises. Also the recent CoT report brought a surprise for gold. After the dismal performance of gold, it had to be expected that large speculators reduced their net long position in the Comex gold futures. However, in the week ending November 12, the non-commercials reduced the long positions by 4,969 to 144,062 contracts and increased the short position by 24,815 to 82,710 contracts, an increase of 42.9% within one week. Thus, the net long position dropped from 91,136 to 61,352 contracts, the lowest level since mid-September this year. As hedge funds and CTAs are rather flexible in changing their positions, it would be rather dangerous to regard this development as a new trend. Nevertheless, it sends the message that large speculators got more pessimistic on the outlook for gold.

Precious metals performed dismal despite more indications that the Fed will not taper this year and the affirmation by Mrs. Janet Yellen that she would pursue an unchanged course of monetary policy. Holdings of the SPDR Gold Trust ETF falling further and large speculators cut the net-long positions in gold and silver. This all is a clear warning that the risk for precious metals is currently more biased to the down- than to the up-side.

On Central Banks and German Economic Doctrines

It was another negative week for most of the precious metals. Only palladium managed to close higher compared to the week before.  Platinum recorded the smallest percentage loss with a decline of 0.6%. Usually, silver is more volatile than gold. However, this week, gold lost 2% while silver was fell only 1.6%. Looking at intra-day charts, it is easy to detect what drove the precious metals lower: central bank policy actions – actual and expected future ones.

Already last week, we wrote that the markets would speculate on a further ECB rate cut after the preliminary consumer price inflation fell to only 0.7% in October. However, at the beginning of this week, the consensus moved towards expecting a rate cut at a later date. But the ECB taught the markets again the lesson that one should not fight against the central banks. It also humiliated the Royal Swedish Academy, which rewarded this year’s Noble laureate to Eugene F. Fama for his theory that financial markets were dominated by rational expectations and information efficiency. The ECB did not hesitate and reacted quickly by cutting the key refinancing rate by another 25 basis points to a mere 0.25%. After the release of the ECB rate cut, the euro dropped against the US dollar by almost 2 cents to 1.33 within 45 minutes. This dragged also the precious metals lower. If Fama’s theory would be correct than the markets should have already priced in the rate cut and should not have reacted so strongly.

The ECB council decision was not unanimous. It has been reported that opposition came mainly from the Northern members, led by the German Bundesbank president Weidmann. The ECB has also been criticized for the rate cut by German economists and institutions. The head of the savings bank association, an economist, stated that the ECB would expropriate the Germans. Representatives of life insurance companies or pension fund managers blamed the ECB for punishing savers. These statements are pure nonsense. First, expropriation means that some property is taken away by the government. However, after the ECB rate cut, savers possess the same amount of bank deposits, which they would hold in the case rates remained unchanged. It is not the duty of the ECB to keep interest rates at such a level that the thrifty Germans earn a positive return on their short-term time deposits.

The ECB can only set short-term interest rates and the duty of the ECB is to maintain price stability, which implies to prevent both, inflation as well as deflation. Thus, the ECB acted according to its mandate. German savers still have the opportunity to switch into other assets, which yield a positive return. That the ECB had to cut rates to prevent a deflation in the Eurozone is a consequence of the German economic policy, which impost austerity measures in the eurozone. And it is also related to another development Germany had been criticized for by the US Treasury, the IMF and the EU, the huge surplus of the German current account, which reached a new record high in September.

Fiscal austerity in many Eurozone countries led to a decline of domestic demand and corresponding pressure on consumer prices. The German export surplus reflects also that Germany’s domestic demand is too small as Germans save more than the companies invest. This is a simple economic accounting relationship, which is not understood by the German politicians and business leaders. Defending or even extending the export surplus implies also that other Eurozone countries will struggle further to increase economic activity by exporting more to Europe’s biggest economy. But as long as total demand in many countries remains sluggish and pressure on consumer prices persist, the ECB policy will have to remain expansionary. This should have a dampening impact on the exchange rate of the euro against other major currencies.

The second push lower for the precious metals was not triggered by actual central bank policy action, but by expectations about future measures. The US labor market report came in stronger than the consensus among Wall Street economists predicted. The number of new jobs created at 204K exceeded the consensus by 83K. Also the preceding two months numbers have been revised higher by a total of 60K additional jobs. Now the markets fear that the FOMC might decide to taper the bond purchases already at the next meeting in December instead of in Q1 next year. Thus, the US bond market sold off and the US dollar strengthened against major currencies, both developments were negative for the precious metals.

However, the market overlooks again that the FOMC is not only focusing on the labor market report. Furthermore, one swallow does not make a summer. The previous reports were weaker than expected. Thus, the FOMC would like to see some confirmation that the labor market improves at a sustainable and sufficient pace. Other economic data was mixed. The ISM reports came in stronger than expected but activity indices from some regional Federal Reserve Banks and consumer sentiment were below consensus forecasts. Therefore, the FOMC is likely to postpone tapering beyond the December meeting.

But tapering is only a question of time. Thus, while the Fed is expected to become less expansionary, the ECB might have to take further monetary measures to prevent a deflation in the Eurozone despite consumer price inflation in some member countries might get close to the target. However, embarking on quantitative easing is more difficult for the ECB than it was for other central banks like the Fed or the Bank of England. While the EU treaties allow the ECB to buy government bonds in the secondary markets, the problem would be which bonds should be bought. Buying government bonds from all countries does not make much sense. If the ECB would buy government bonds of those countries where the risk of deflation is the highest, than complaints would come from Germany and other Northern countries. A difficult task for the council to select the proper instruments. But as the ECB demonstrated, the council is ready to act in time and it would ease monetary policy even further to fulfil its mandate. The implication for the precious metals is that they might remain under pressure by a firmer US dollar.       

Platinum defies negative factors due to labor unrests

Some analysts and commentators came to the conclusion that the labor unrest in South Africa would have no impact on the price of platinum. However, platinum was the only metal posting a gain this week. All other precious metals lost more than they gained the week before. Those analysts pretending that the labor unrest would have no impact on the price of platinum made a simple mistake. They just compared the price performance of platinum with percentage price changes at times of former labor unrests in South Africa. They made the implicit assumption that the labor conflicts were the only factor determining the price movement of platinum. But this is not correct. Many econometric models for the fair value of precious metals show that other factors also play a crucial role. These models could be either of the linear regression type or Vector Auto-Regressive type (VAR). Taking those factors into account and not treating them as constant leads to a different conclusion. Labor unrests still have a strong impact on platinum prices!

Two variables, which are included in those models and which are significant, are the development of the US dollar against the five major currencies as measured by the US dollar index and the price of crude oil.

In our fair value models, we include the price of the front-month light crude oil future traded at the Nymex division of the CME group, which is based on the WTI oil sort. This oil sort was long the benchmark. Including the front-month of the ICE Brent future would not change the results considerably. The price for both sorts declined last week. The front-month WTI future lost 3.3% compared to the previous week. One reason behind the price decline of crude oil was the build of inventories at Cushing despite the rise in refinery input and capacity utilization, which exceeded expectations of many analysts and traders. However, the drop of the oil price also reflects some weaker economic data. Thus, the decline of the oil price signals not only a lower inflation risk but also a slower pace of economic activity. Both developments are negative for the demand for precious metals including the PGMs.

The FOMC kept the volume of monthly bond purchases unchanged as widely expected. However, the market was surprised by the FOMC statement recognizing a weakening of economic activity. This reaction again demonstrates that markets are not always rational. Rewarding Eugene F. Fama with the Noble laureate is not understandable and the Swedish academy looks foolish ones again. The shut-down of the US government has an undeniable impact on economic activity. Some economists estimated a loss of Q4 GDP by $24bn, which is not a negligible quantity. That economic activity in the US decreased already in September is also not really surprising as the shut-down was looming and there were no signs that it would be averted by a last minute compromise.

Against the backdrop of a further delay of tapering and the FOMC’s assessment of a weaker US economy, one would not expect the US dollar to strengthen. However, this is exactly what happened. But currencies always involve two currencies in a pair, which indicates that developments in other countries might have been decisive for the stronger US dollar. The Japanese yen weakened against the US dollar on a smaller than expected increase of industrial production. But as other economic data came in stronger than expected, it is more likely that the weaker yen was caused by cross exchange rates, especially by the EUR/USD pair. The euro weakened against the US dollar from 1.3804 to 1.3485, a depreciation of 2.3%. But the euro came under pressure mainly during the last two trading days.

It might be a coincidence, but there were two related factors, which contributed to the weaker euro. There were complaints against the strength of the euro reported on Thursday. The rise of the euro above 1.38 against the US dollar is probably less of a problem for the German export oriented economy. However, for the Southern European countries, which had to take severe austerity measures in order to regain competitiveness, a stronger euro is a serious problem. Further wage cuts to remain competitive would only send those countries back into recession and would aggravate the social and political tensions.

Later on the same day, the Eurozone preliminary October inflation rate was released. The HICP inflation dropped further to 0.7%, far below the ECB target of close, but below 2%. And the stronger euro is one of the factors contributing to the increased deflation risk. While the Austrian central bank governor already ruled out a further rate cut, the market is speculating on such a move. But also some other ECB council members from the Northern part of the Eurozone oppose such a move. But due to the fiscal austerity imposed, aggregate demand could not be revived by fiscal policy without a change in the policy regime. Such a regime shift appears to be impossible. If the ECB takes it task seriously, it would have to take measures to prevent slipping into deflation. Otherwise, the ECB might repeat the mistakes made by the Bank of Japan which led to the still lasting deflation in Japan.

Given the constraints, the ECB has to take measures that monetary policy gets more expansionary in order to reduce the deflation risk. Thus, the markets are speculating on a further rate cut, some unconventional measures of quantitative easing or a combination of both. Those measures would have the welcome impact of weakening the euro against other currencies.

The outlook for more easing by the ECB is negative for the precious metals. That platinum increased by 0.2% in this environment, while gold and silver dropped 2.7% and 3.1% respectively in the week on week comparison is remarkable. And it underlines that the labor conflicts in South Africa have a positive impact on the price of platinum. That palladium only declined by 0.5% also underlines the relative better performance of the PGMs. The outperformance of the PGMs over gold and silver is likely to continue for the time being.   

Further range trading of precious metals despite tapering being delayed

The positive week for precious metals does not change our forecast that gold and silver are likely to remain in a broad sideways trading range. Only the PGMs might break out to the upside, but this depends on the supply from South Africa, as there is always the risk that labor unrest could lead to production shortfalls.

One factor contributing to the positive performance was the flash estimate of the HSBC manufacturing PMI for China. While the consensus forecast predicted an increase from 50.2 to 50.5, the index rose to 50.9, which points to a far stronger expansion of the manufacturing sector. However, this is not only a positive indication that the GDP growth of the Chinese economy is probably accelerating further in the final quarter of 2013. Given the strong dependence of China on exports, it is also a positive sign for the global economy after the recent forecast downgrades by the IMF and World Bank.

Just a few weeks ago, Eugene Fama was rewarded with the Noble laureate in economics. However, his theory rational expectations in financial markets, which leads to information efficiency, has been proven wrong again. Several members of the FOMC already stated that a decision to taper would be delayed into next year given the uncertainty about the economic situation caused by the government shutdown. Thus, it should be already priced in that the FOMC will not decide to reduce bond purchases at the last two meetings in this year. However, only after the release of the September US labor market report this week the financial and the precious metals markets reacted strongly.

Instead of creating 182K new jobs outside of the agricultural sector, the US economy added only 148K persons to the payrolls. The July figure was revised down to 89K (from 104K) while the August figure was revised up to 193K from 169K previously reported. However, for the FOMC, the unemployment rate is more important than the number of non-farm payroll additions. The unemployment rate edged further down to 7.2%. But there was only a slight decline of the number of unemployed persons. The negative aspect is that the number of persons not being in the work force increased further to 90,609K. The number of persons leaving the work force exceeded the decline of the persons being unemployed.

The FOMC already pointed out in the statement following the September meeting that the labor market has not developed as expected. However, the markets did not understand the message and only complained that the FOMC did not decide as the majority of Wall Street economists predicted. But as the recent labor market report shows, the majority of the FOMC voting members was smarter than most Wall Street economists despite also not having the September labor market report.

All information was not reflected in the prices. It took the market more than one month to recognize that the FOMC took the right decision and that tapering will be delayed into 2014. Thus, it has been demonstrated again that rational expectations and market efficiency does not always prevail in financial and commodity markets.

The yield on 10yr US Treasury notes came down to 2.5% again. In its statement released after the September FOMC meeting, the committee also mentioned the increase of financing rates as a reason to postpone tapering. We argued that the FOMC would probably feel more comfortable to reduce the amount of monthly bond purchases at a rate of around 2.5% on the 10yr US T-note. However, given outlook that tapering is likely to be delayed for several reasons into 2014 and that the debt ceiling has also been lifted, there is still some downside potential for yields on US Government paper. Thus, we would currently remain overweight duration on a US Treasury portfolio. But as the yield on 10yr US Treasuries approaches the level of 2.25%, we would start switching out of long-term into short-term US Treasury paper and thus, reduce the duration of a portfolio to neutral. Yields on 10yr US T-notes below 2.25% would be a reason to be duration underweight.

Gold and silver should profit from the outlook for tapering being delayed into 2014 and for further declining yields on US Treasuries. Thus, also the precious metals have still some upside potential. However, many analysts are still bearish for the precious metals in the final weeks of this year and for 2014. Some bank analysts have even reduced their forecast for gold and silver prices next year. Also the development of gold holdings in the SPDT Gold Trust ETF sends a warning signal. Thus, the most likely scenario is that gold and silver remain caught in the trading range of the third quarter this year. The chances for a breakout to the upside are higher for the PGMs, but this depends crucially on the supply from South Africa.     

Gold Price Movements during the US Government Shutdown

While the US government was shut down, we were also offline for almost two weeks. However, this was not related to any political decisions but due to some technical problems.

In this blog, it has always been argued that it is not just one factor having an impact on the development of precious metals prices. Nevertheless, we were surprised by the price movement of gold since the last Friday in September. Already at this weekend, it was obvious that there would be no last minute compromise to pass the budget in time and that the government shutdown was unavoidable. Given the stance of the Tea Party fraction within the Republicans, it was even doubtful whether the debt ceiling would be increased right in time to avoid a default of the US Treasury. Therefore, it was rather likely that the FOMC would postpone a decision to taper the bond buying program further into the future. Now, recent comments from some – even hawkish - FOMC members point in this direction.

In addition, the political wrangling in Washington DC argued for a weakening of the US dollar as foreign investors might reduce holdings of US Treasury paper and repatriate the funds or invest in more secure government bonds like UK Gilts or German Bunds. And indeed, as the risk of a default of the US government increased, the US dollar index declined, which reflects a weaker US dollar against the major currencies.

Thus, there were three factors – safe haven demand, postponing of tapering by the FOMC and a weaker dollar – pointing to a firmer price of gold and other precious metals. But gold was during this past three weeks the weakest precious metal. Even after the rebound following the last minute compromise to lift the debt ceiling for buying time for further negotiations on the budget, gold is still ended the trading week below the close of the last Friday in September, while all other precious metals posted gains on balance during this period.

Thus, the question is, why did gold trade lower to around 1,250$/oz and then rallied 65$/oz after the US Congress passed the bill to increase the debt ceiling? One possible answer might be a trade recommendation issued by Goldman Sachs to go short gold. The precious metals analyst of Goldman Sachs recommended to short gold already earlier this year and he was right in the second quarter. Thus, some large speculative accounts might have followed his recommendation. This would also be a possible explanation for the stronger price swings at the open of the gold futures trading session at the COMEX division of the CME group.

Unfortunately, due to the government shutdown, the CFTC had not been able to release the weekly “Commitment of Traders” report. The only available data is on the gold holdings of the SPDR Gold Trust ETF. Over the last three weeks, the gold holdings in the ETF dropped from 906 to 882.2 tons. It is well known that the whale in this ETF is John Paulson and his hedge funds. The performance of his funds was very poor in the first half of 2013. Thus, some investors might have regarded the recovery of gold during the third quarter as a good opportunity to withdraw money. Therefore, forced hedge funds liquidations might be another reason for the weak start of gold into the final quarter of 2013. However, even if John Paulson had been forced to liquidate positions in the SPDR Gold Trust ETF, it would not explain the strong rebound of gold after US President Obama signed the bill to increase the debt ceiling and to re-open the government.

Many commentators attributed the strong rise of gold to short-covering. The trading volumes of gold futures at the CME are no proof for this theory as for each contract bought there is one contract sold. Fortunately, there is other data available, which could provide some clues about covering of short positions, the gold forward rates – or short GoFo – as provided by the LBMA and the corresponding gold lease rates.

In mid-September, the 1mth gold forward rate turned positive again and rose up to 0.122% by the end of last month. During the first two weeks of October, the 1mth GoFo edged lower, but clearly remained positive. The picture changed completely during this past week, with the 1mth gold forward rate falling from 0.08 to -0.06% and the gold lease rate for the same maturity increased from 0.09 to 0.235%. The movements for other maturities are similar. Often, a rise of the gold lease rate is accompanied by a fall of gold inventories held in CME warehouses. But this was not the case this time. While the gold lease rate rose, the gold inventories remained unchanged until Tuesday and the decline on Wednesday was not at an unusual size.

Central banks play a major role in the gold lease market. However, they are also a major gold investor. In a recent report, central banks as a group had been criticized as being the worst gold investor buying at the peak and selling at the low. Furthermore, depending on accounting rules and book entry levels, the revenues from leasing gold might not be sufficient to compensate the loss due to write downs on gold holdings. Thus, central banks might have become less willing to lease gold to hedge funds, which speculate against central banks as gold investors.

Thus, the rise of gold lease rates and less gold available for leasing is probably the reason for the rebound of gold. Hedge funds following the advice of Goldman Sachs to sell gold short might have still made some profits. However, those profits are much smaller than the ones during the second quarter. The reason that Goldman Sachs trade recommendation was less successful or even might have led to losses for some short sellers is a basic mistake of the precious metals strategist. He obviously violated the old rule that one should never fight against the central banks.       

US Politics and Precious Metals

The recent comments concerning the precious metals markets still focus on tapering by the Fed. In this context, one would expect that the forthcoming US labor market report, which is scheduled to be released on Friday October 4, 2013, might be the most important factor for the precious metals this week. A strong US labor market report is probably negative for gold as it would increase the likelihood for reducing the volume of bond purchases at the next FOMC meeting.

However, the crucial question is: What makes the US labor market report a strong one? The non-farm payroll figure is predicted by the consensus of Wall Street economists to increase by 10K to 179,000 new jobs created in September. Thus, a significantly higher non-farm payroll number might be already regarded by some traders as a strong report. But one has to keep in mind that also the figures for the two preceding months are subject for revisions. Even if the non-farm payrolls comes in higher than forecasted the labor market report could still be perceived as a weak one in the case that the household survey disappoints.

The recent decline of the unemployment rate was the result of a low labor market participation. It has been pointed out in this blog that during the summer vacation months, there is little incentive for unemployed persons to look for a new job and to return back to the labor force. However, chances might increase after the US Labor Day holiday and thus, some persons might decide to join the labor force again and look for a new occupation. In this case, the unemployment rate might edge up again slightly. An increase in the unemployment rate would most likely convince the majority of the FOMC voting members that the decision made in September was the right one and it would be still too early to taper.

Thus, it is hard to predict, which influence the US labor market report might have on the price development of precious metals. If the majority of market participants comes to the conclusion that the labor market report would lead to a further delay of tapering, then precious metals might trade higher. But the upside might be capped as many economists and commentators could argue that tapering would be only postponed by one FOMC meeting.

However, another political development in Washington could lead to the result that the BLS (Bureau of Labor Statistics) might not be able to release the labor market report on October 4, 2013. The US administration might be forced to close all non-essential departments if not a last minute compromise on the budget for the next fiscal year starting on October 1st is reached. Furthermore, the US Treasury is approaching the debt ceiling and it is estimated that by mid-October the US Treasury runs out of sufficient funds to honor all obligations in time.

Currently, it seems that financial and commodity markets are relatively relaxed. The situation is not uncommon and had been solved just right in time several times since the summer of 2011. Kenneth Rogoff and Carmen Reinhart titled their famous book “This time it is different” as a warning. Whenever somebody used this argument to promote an investment, times were not different and the investment ended in losses. This might also explain that markets are currently relatively calm. However, is the current situation really the same as it had been before?

In the past, there had been already some movements towards a compromise, albeit slowly. This time, there appears to be not any compromise in sight. The situation resembles like two trains collide at full speed and none of the drivers stepping at the brakes. The Tea Party fraction of the House Republicans sticks to its demands and is not showing any willingness to move even one inch towards a compromise. At the time of writing, a last minute compromise appears light-years away.

A failure to reach an agreement on the budget for the next fiscal year would have serious negative consequences for the US economy. The Fed would have to postpone tapering for quite some time into the future. The normal reaction among investors in periods of economic weakness would be to buy the government bonds and notes. However, with the looming debt ceiling and the risk that the US Treasury might default on its obligations, the US Treasury market is not the safe haven it used to be. But gold will not default and therefore, if a rush into safe havens sets in, gold might rally like in the summer of 2011. Only in this respect, times might not be different.

Swarm intelligence and the Fed: Yes, the majority can be wrong!

Two thirds of the Wall Street economists polled either by Bloomberg or ThomsonReuters were wrong. The FOMC did not start tapering at its September meeting. Now many of those economists, but also strategists and even some traders and fund managers talking to the media behave like bad traders, which blame others for their losses. In this case, they blame the Fed for misguiding them. However, this criticism of the FOMC is unfounded and unfair. Those, who have bet on tapering in September, should better carefully analyze which mistakes they made in misinterpreting the FOMC statements.

When Fed chairman Bernanke made the famous statement at the Congress testimony in May, he used the simple conditional form. However, it can be observed times again and again that some persons, among which are also journalists, have difficulties to make the right distinction between the simple conditional and the simple future form. Many analysts, economists and journalists interpreted the sentence that the FOMC might decide at one of the next few meetings to reduce the volume of bond purchases as that the FOMC will make the decision. Furthermore, the expression next few meetings was reduced to the next three meetings and thus, many just concluded that the FOMC will taper in September.

However, the intention of Mr. Bernanke was just to prepare the market for an event which was a possible outcome of the discussions within the FOMC. But the decision was still open. Reading carefully the FOMC statements and the comments made by Fed chairman Bernanke and some other voting members of the FOMC, it was clear, there was no pre-commitment to decide to taper at the September FOMC meeting. Former ECB president Trichet used to emphasize at each ECB press conferences that the ECB was not pre-committed. But even if Mr. Bernanke had pointed out again and again that the FOMC was not pre-committed to taper in September, there would have been still some traders, fund managers or economists who did not get the message and then complaint about being misguided by the Fed.

The FOMC always emphasized that the decision concerning tapering the volume of bond purchases would be data dependent. However, the FOMC never stated that a certain level of the unemployment rate would automatically lead to a reduction of bond buying. Furthermore, the data set relevant for the FOMC decisions also includes the Fed projections for GDP growth and inflation, which a central bank should take into account due to the impact lags of monetary policy. Again, some commentators now complain that the FOMC has revised its projection for GDP growth lower for this year by 0.3 percentage points and that this downward revision is a further argument for not tapering.

Some commentators also criticized that data dependency includes the change in financial market conditions, which occurred after Fed chairman Bernanke pointed out the possibility of tapering at the testimony on May 22, 2013. However, the FOMC cannot ignore the rise on yields on US Treasury notes and bonds as well as on mortgage bonds. If financial markets overshoot on the announcement of a possible action, then these markets should not be surprised that the possibility does not became reality. However, it is not the Fed to blame. Economists and traders just ignored that the market reaction could have a feed-back impact on the FOMC decision. Those, economists and traders who got the FOMC wrong have to do just a better job.

Data dependency also includes to consider future risks. One of these future risks is the US fiscal policy and that politicians tend to make the same mistake not only twice but several times. The Tea Party fraction of the House Republicans is again following an all or nothing policy and is unwilling to make a compromise. They risk again that the US might default on the Treasury debt. Such an event would have huge negative impacts on the US economic activities. Thus, prudent monetary policy just takes a wait and see attitude before reducing the monetary stimulus.  

We pointed out several times that the publicly available data for the labor market and price development were sufficient reasons for not tapering in September. The further arguments provided by the FOMC does not make the Fed policy unpredictable. As Lord Keynes once stated: “If the facts change, I change my mind. And what do you do, Sir?” The FOMC always made it quite clear that they would act like Lord Keynes by emphasizing again and again that the decision to taper is data dependent. Those, who got the FOMC wrong have obviously ignored to take changing facts into their analysis.

For the yield on 10yr US Treasuries, we stated that they would be very attractive at a level around 3% as the Fed Funds rate would remain at the extremely low level for some time, even after the Fed starts to reduce the volume of bond purchases. We came close to this level. After the recent FOMC decision, yields came down to 2.75%. Also at this level we regard 10yr T-notes still as a buy. It appears that the FOMC would prefer yields to be more in the vicinity of 2.5% before tapering.

Gold and other precious metals rallied after the FOMC announcement, but pared gains on Friday and even closed down in the week over week comparison. The market speculates now that the FOMC would taper at the next meeting. While it is also not yet a done deal that the FOMC will lower the volume of bond purchases in October (observe the risk stemming from the fiscal policy for the US economy) the commodity markets react like the decision has already been made. But the FOMC is not pre-committed. Nevertheless, the market reaction strengthens our assessment that precious metals remain trading sideways and that the upside potential is capped for the time being.