Chicago Fed Evans’ Forward Guidance And GLD

Summary

• Chicago Fed President Evans is willing to risk higher inflation in the future with current low inflation environment, and his conditions for liftoff are noted.
• Evans suggested that the FOMC is considering 2 rate hikes, each in 2015 and 2016 at 25 basis points each, and this is an important forward guidance.
• This unofficial forward guidance is bullish on the USD and bearish on GLD.
• Despite Evans’ dovish speech, GLD is not affected and continues its downtrend, and is being pulled down further by the strong labor market report.

By FX Analyst

The impressive 06 March, 2015, labor report saw 295,000 new jobs added to the market and the unemployment rate down to 5.5%. In this context, we can take a look at the Chicago Federal Reserve President Charles Evans’ speech on 04 March, 2015. A point to note is that Evans is a voting member of the Federal Open Monetary Committee (FOMC) and a noted dove.

The point of this article is to explore his dovish views with his attention to the low inflation environment and speculate if the latest labor report will sway his vote in the next week’s FOMC meeting. We will then translate this into the movement for gold prices, as the current low inflation environment is reducing the appeal of gold and the prospect of higher interest rates is increasing the holding cost of gold. These twin pressures are pulling investors away from gold, as the worries of financial instability over Grexit fades from Europe.

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Right now, the key point of contention and a major decision point facing the FOMC is the pace and magnitude of its rates liftoff and the subsequent rates increment. There are those who are in the dovish camp, such as Evans, who are in support of a later rate hike, then there are those in the hawkish camp, such as the New York Fed President William Dudley, and finally, there are those in the centrist camp as St. Louis Fed President James Bullard.

It is noted that the dovish camp focuses on the current low inflation environment for prices and wages, even as it acknowledges the strong economic growth as the reason to push off the rate hike. Those on the hawkish camp emphasize on the strong economic growth, along with the accompanying strong labor market, and they discount the current low inflationary environment as transitory. The low energy price is seen as a boost to consumers, especially those in the lower income tiers who spend a larger portion of their income on energy needs, and it allows them to spend more on other areas for their enhanced welfare. They will then note that the effects of the monetary policy happen with a time lag, and hence it is important for them to act early even before high inflation rears its head.

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I am biased towards the hawkish view and would expect the Fed to liftoff in mid-2015 or earlier. However, it is still advisable to consider the dovish view, especially if one of them is voting on the FOMC.

Impact On Gold And SPDR Gold Trust ETF (NYSEARCA:GLD)

The latest jobs report saw an average of 288,000 jobs added over the 3-month period from December 2014 to February 2015. This is higher than the average of 265,000 last year, as noted by Evans. My opinion is that even with such a strong labor figure published last week, it is unlikely for Evans to change his mind. However, it is more likely that he will be persuaded to go with the majority of the FOMC. After all, according to the projections done by the staff of the Chicago Fed, he thinks that the natural rate of employment is at 5.0%, which is significantly higher than the official FOMC range of 5.2% to 5.5%.

My view is that Evans’ urging of patience may no longer find traction with his FOMC colleagues when he meets with them next week in Washington. This is after the strong labor report which will give noted and influential hawks more ammunition in advancing their cause. They include New York Fed President and FOMC Vice Chairman William Dudley and Governor Stanley Fischer who is also the Fed Vice Chairman. In fact, Chair Yellen who was considered to be dovish in the Bernanke Fed in her position as San Francisco Fed President and later Fed Vice Chair with her focus on employment slack is now seen as relatively hawkish with her interpretation of market-based inflation compensation, as a result of lower risk premium and not lower inflation expectation.

We can see from the chart above that the SPDR Gold Trust ETF remains on the bearish trend after Evans gave his speech on the 4th of March, as pointed by the arrow above. Even if we were to consider that the market needs 1 more day to digest his speech in different parts of the world with different time zones, there is also no notable bullish impact. The impact of the strong labor report is clear with a gap down 2 days later as seen on the chart.

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GLD tracks the performance of gold after fees, and it is the easiest way to gain exposure to gold or short it in terms of time and expenses. GLD has a market capitalization of $28.35 billion and daily transaction volume of around 7 million. Hence, it is one of the most liquid ETF in the market. This would mean that there are still people willing to sell GLD to you and with less slippage.

The golden nugget in Evans’ speech about the possibility of 2 rate hikes in 2015 should not be discarded. It would serve as an anchor in our expectations of higher interest rate and as clear of a forward guidance as there is in the market. It should be noted that this is an unofficial forward guidance, and coming from a noted dove has added weight. The official version would be released by the official FOMC statement by Chair Yellen. In my opinion, this would be the most useful part of his speech overall.

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