Yellen: Fed will raise interest rates, let economy "coast"

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  Right: Federal Reserve Chair Janet Yellen Left: moderator Susan M. Collins, Sanford Weill Dean of Public Policy at the University of Michigan Gerald R. Ford School of Public Policy.

  Tyler Scott / Michigan Radio

Federal Reserve Chair Janet Yellen said at a University of Michigan event today the Fed plans to gradually raise short-term interest rates.
Yellen said the change in monetary policy comes after years of holding short-terms interest rates at low levels.
“I think we have a healthy economy now ... but it’s been a long time coming,” Yellen said.
Yellen said the current unemployment rate of 4.5% is “even a little bit below” what Yellen and her other colleagues at the Fed would consider “full employment.” She said inflation is “reasonably close” to the Fed’s stated goal of two percent.
She said the economy's current moderate level of growth is due in large part to increased consumer spending, but that the health of the housing market has improved, as well as investment spending and the global economy.
“Looking forward I think the economy is going to continue to grow at a moderate pace,” Yellen said.
Yellen, who assumed office in 2014, comes to the end of her term as Fed chair next year. She said the new monetary policy of the Fed, including raising interest rates, is focused on maintaining current levels of economic growth.
After the global financial crisis of the mid-2000s, the Fed did practically everything it could from a monetary policy perspective to increase consumer spending, including holding the “overnight” interest at nearly zero percent for years, according to Yellen.
But in those years, lowering short-term interest wasn’t enough. The Fed also bought treasury and mortgage-backed securities to lower long-term interest rates, according to Yellen. In addition, the Fed practiced what Yellen called “forward guidance,” reassuring the financial markets that interest rates would remain low.
“Before, we had our foot pressed down on the gas pedal trying to give the economy all the ‘oomph’ we possibly could,” Yellen said. “Now, [we want to be] allowing the economy to coast and remain on an even keel.”
Yellen also said it is important to begin rising interest rates before the economy “overheats."
“We don’t want to be in a position where we have to raise rates rapidly, which could conceivably cause another recession,” Yellen said. “We want to be ahead of the curve and not behind it.”

Why We Could Get Negative Interest Rates Even Though The Fed Is Hiking

Federal Reserve Board Chairman Janet Yellen speaks during a briefing on March 15, 2017 in Washington, DC. / AFP PHOTO / Brendan Smialowski/Getty Images

At its March meeting, the Federal Reserve raised interest rates by 0.25%. In doing so, it hiked rates for only the third time since 2006. However, in a strange turn of events, the Fed’s move was perceived as a dovish one by the markets.
That’s because even with inflation at its highest level since 2012, the Fed said monetary policy will remain accommodative “for some time.” As has been the case in the past, the Fed is willing to let inflation consolidate above its 2% target before embarking on a more aggressive tightening path.
This willingness to let inflation “run hot” means even as nominal rates rise, real rates—that is, the nominal interest rate minus inflation—are headed into negative territory.
So what are the implications of negative real rates?
Negative Real Rates Drive Gold Higher
The consumer price index (CPI), the most widely used measure of inflation, averaged 2.67% for the first two months of the year. Even if inflation averaged only 2% for all of 2017—the Fed’s target—it would be a big problem for investors and savers alike.
Today, a one-year bank CD pays about 1.4%. Therefore, anyone who keeps their money in a bank is watching their purchasing power erode.
Of course, there are other options. You can put your money in U.S. Treasuries or dividend-paying stocks—both popular sources of fixed income.
However, with both the 10-year Treasury yield and the average dividend yield for a company on the S&P 500 hovering around 2.35%, that doesn’t leave much in the way of real gains if inflation is running at 2% per annum.
If inflation rises or bond yields fall, real interest rates will be pushed into the red… and that’s very bullish for gold.
Gold is known as the yellow metal with no yield, but simple math tells us no yield is better than a negative one. Because of this, gold has done well when real rates are in negative territory. In fact, real US interest rates are a major determinate of which direction the price of gold moves in.
A study from the National Bureau of Economic Research found that from 1997–2012, the correlation between real U.S. interest rates and the gold price was -0.82.
This means as real rates rise, the price of gold falls and vice versa. A -1.0 reading would be a perfect negative correlation, so this is a tight relationship.

The Fed’s hesitation to raise rates faster is contributing to another trend that is also bullish for gold.
A Falling Dollar Equals Higher Gold Prices
In the six weeks following the US election, the dollar skyrocketed 5.6%—a huge move for a currency.
However, since the beginning of the year, the greenback has given back most of its post-election gains. This is in part due to the Fed’s “dovishness” on interest rates.
The strong negative correlation between gold and the U.S. dollar is a major reason the yellow metal is up over 9% year to date.

Market Realist

In the March edition of Bank of America Merrill Lynch’s Global Fund Manager Survey, respondents thought the dollar was at its most overvalued level since 2006. As the chart shows, the survey has a good track record of determining when the dollar is overvalued.

Bank of America Merrill Lynch

Tying it all together, what do these trends mean for gold?
Gold Should Go Higher from Here
With arguably the two biggest drivers of the gold price trending in the yellow metal’s favor, gold is likely to go higher. Although the dollar could rise if Washington implements some structural reform, real rates aren’t headed higher anytime soon based on the Fed’s actions.
Bank of America Merrill Lynch said these two trends were part of the reason why it upgraded its forecast for gold to $1,400 per oz. by year-end. As the chart below shows, the market turned bullish on gold following the Fed’s December rate hike.
In closing, after nine years of doing its utmost to generate inflation, the Fed has finally succeeded. If past is prologue, as inflation rises over the coming months, gold will do very well.
If you’re considering getting some gold before it goes up, do your homework first.

Robert Bobby Darvish Platinum Lending Solutions