Critical Information Before Tomorrow's Fed Decision

Dec 14, 2021

Critical Information Before Tomorrow’s Fed Decision

Stocks vs inflation vs The Fed… Who blinks first?

This week we explore:

• How 40-yr high inflation, all-time high markets, and the Fed’s tapering all play out in this week’s FOMC meeting.

• Mythbusting the relationship between assets and the federal funds rate.

• The seasonality of gold and silver prices and why tomorrow may present the best buying opportunity we could ever see.

“You got to choose between tightening of your belt or losing of your pants”

― Novjot Singh Sidhu

It’s time to tighten our belts or lose our pants. At least that’s the message many are expecting to hear tomorrow from the Federal Reserve.

Tomorrow, the Fed announces to the world their policy changes. It’s expected that the Fed will increase the speed of tapering their bond-buying program and clear the way for interest rate hikes beginning as early as March of 2022.

Goldman Sachs has predicted that the Federal Reserve will need to hike interest rates 3 times in 2022. Former Treasury Secretary Larry Summers is calling for 4 rate hikes next year.

Whatever the ultimate reality, the Fed has promised it won’t begin raising interest rates until they have ended their bond-buying program. So we won’t be seeing any surprise rate hike from the Fed tomorrow, especially during the holiday season. What we will see is a speed up their taper and a stage for earlier rate hikes than the Fed anticipated.

According to Larry McDonald of The Bear Traps Report, “if the Fed actually speeds up the taper and hikes four times in 2022, the Nasdaq would be down 50% and bitcoin could be down 70%.”

Unfortunately for the Fed, kicking the can won’t work and is no longer an option.

You see, the Fed’s action of adding to the money supply and increasing their balance sheet from $4 Trillion to $8.65 Trillion has created a nasty bout of inflation. This month’s CPI numbers came in at 6.8% and printed the highest inflation in 40 years. While the Fed would love to keep the balance sheet expansion and bond-buying on autopilot, inflation is forcing their hand to act.

The Fed is now going to be tightening. The big question is how aggressive will that tightening be, and how will the market respond?

For the last 18 months, just about every investor in the world has been front running the massive liquidity added by the Federal Reserve. Stocks are up roughly 51% since April of 2020.

It’s why the markets are so uncertain today, and why tomorrow's Fed policy decision is so critical to the future direction of the market. What happens when the Fed takes the punchbowl away?

As we enter into another round of tightening, we thought it imperative to share with our readers what happens to stocks and gold prices when the Federal Reserve actually takes action and tightens monetary policy.

There is a big misnomer in the world of gold that must be cleared up once and for all.

For some reason, probably due to a combination of a lack of awareness, coupled with a lack of great information in the gold investment space, and then compounded by a Wall Street that is incentivized to misrepresent and distort the truth, there is a mistaken belief that rising rates and a tightening Federal Reserve are bad for gold prices.

The opposite turns out to be true historically.

When the Fed is creating loose conditions, stocks and bonds have historically risen, and gold prices have fallen.

It’s when the Fed stops expanding the balance sheet and begins to tighten that the results flip and gold and commodities then outperform. While many mistakenly believe otherwise, rising rates have historically been great for gold.

The following chart comes from the St Louis Federal Reserve and tracks the Fed funds rates all the way back to the year 1955 through today. We have highlighted key eras in yellow to show both the direction of interest rates and then the impact on stocks and gold prices.

Pay particular attention to what happens when the Fed is directionally loose and directionally tight.

Tightening Fed Rate Hiking Era 1971 – 1980 Fifty years ago, in March of 1971, the Fed Funds rate stood at 3.7%. Over the course of the next nine years, the Federal Reserve would raise their Fed funds rate dozens of times, hitting an all-time high of 20% in 1980. During this decade, the Fed raised rates by over 16 percentage points and gold prices rose a total of 1,726%. In this exact same time frame, the Dow Jones would rise a total of only 4% over a near ten-year period. Fed “Tighty” bad for stocks and good for gold. Loosening Fed Rate “Lowering” Era 1981 – 2004 For the next 24 years, the Federal Reserve lowered their Fed Funds rate from 20% all the way down to 1% in 2004. Over this 24 year span where interest rates dropped continually, gold prices dropped more than 25%. During this span, the Dow Jones would increase a whopping 1,114%. Fed “Loosey” great for stocks and horrible for gold. Tightening Fed Rate “Hiking” Cycle 2004 – 2006 In July of 2004, the Fed began a rate hiking cycle. During these years, the Federal Reserve raised rates a total of 17 times. They raised the Fed Funds rate from 1% in July of 2004 through July of 2006 to 5.25% before they were forced to pause. Gold prices rose 55% from $397 to $613. During this span, the Dow Jones would return only 7.9%. Fed “Tighty” bad for stocks and good for gold. Of course, everything changed in 2008. In response to a massive debt collapse, the Fed was forced to pull a tool out of their toolbox that they had not used before. Lowering interest rates to 0% didn’t work to stimulate the economy. This is when the Fed began Quantitative Easing and expanding their balance sheet. Loosening Fed Rates at 0% in QE Era 2011 – 2015 One would naturally think that expanding the money supply would be good for gold prices. Ironically, the opposite has turned out to be true. From August of 2011 through December of 2015, while the Federal Reserve kept interest rates at 0%, and expanded their balance sheet from $2.4 Trillion to $4.48 Trillion, gold prices would drop 39%. During this time, the Dow Jones would rise 52%. Fed “Loosey” great for stocks and horrible for gold. Tightening Rate Hikes In QE Era 2015 – 2019 The Federal Reserve attempted to “normalize” rates beginning in December of 2015 and began their first-rate hiking cycle in nearly a decade. Interestingly, the date marked the low point for gold prices which had fallen to $1,061. As the Federal Reserve hiked rates 10 times over the next 2 years, gold prices would rise 24% from $1060 to $1322. During this hiking cycle, the Dow Jones also increased by 47%. Fed “Tighty” good for stocks and gold. Loosening Rates at 0% in QE Era 2020 – 2021 Once again, this time in response to the coronavirus, the Fed was forced to lower rates to 0% in mid-April of 2020. Since that time, the Fed has left interest rates at 0% and more than doubled their balance sheet, the Dow Jones has increased a whopping 51% while gold prices have only increased 3%. Fed “Loosey” good for stocks and did nothing for gold. The data is undeniable and indicates that a “tightening” Federal Reserve will likely coincide with gold prices that rise alongside tighter conditions. Stocks fare far worse historically when this occurs. Of course, the biggest boom for gold, and when prices rocket higher, is when the Fed is forced to walk back their tightening stance and add more liquidity. Which leads us to a final thought. The seasonality of gold and silver prices. We went back over the past 6 years since the Fed first began tightening to look at how gold and silver prices performed from December 15th through February 20th of the following year. Gold prices have risen an average of 7.3% and silver prices have risen an average of 9.5% during this eleven-week season. This is why we shouldn’t be surprised if today marks the low for silver and gold prices as the Fed heads into directional tightening. Best, Adam Baratta Editor-in-Chief Brentwood Research