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What we know is that the Fed is biased toward rate increases as long as the economy is growing. This is because the Fed needs to raise rates to 3.25% before the next recession in order to cut them back to 0% when the recession hits; approximately the amount of cutting needed to pull the economy out of recession.
The Fed is unlikely to reach this goal without either causing a recession, or facing one anyway, but they will try.
Simply because the Fed wants to cut rates does not mean they will. The entire course of 2015 and 2016 was a case study of not being able to raise rates more despite wanting to. What stands in the way of rate hikes? There are four hurdles, which can arrive singly or in combinations.
These are deflation, job losses, technical recession, and tighter financial conditions from sources other than rate hikes. The last hurdle includes a number of conditions such as global contagion or a stock market correction.
There are many examples to illustrate this. The Fed was on track to raise rates in September 2015, but did not do so because of the Chinese devaluation and U.S. stock market correction in August. The Fed was on track to raise rates in March 2016, but did not do so because of the stock market correction from January 2 to February 10, 2016.
The Fed also did not raise rates in September or November 2016 because of the U.S. election, but that’s a one-off constraint on policy. The Fed is highly political, protestations to the contrary notwithstanding.
So, forecasting the Fed is straightforward. If you do not see any of these hurdles, the Fed will raise rates every March, June, September, and December from now until the end of 2019. If you do see these hurdles in strong form, the Fed will not raise rates. Insiders call this a “pause,” and that’s a good way to understand it.
As of now, none of the pause indicators are flashing red so the Fed will raise rates in March. That rate hike is not fully discounted in the market yet. The Fed’s job from now until March will be to communicate the likelihood of a rate hike through speeches, leaks, and various statements. This will be a headwind for gold and it should not be surprising if gold trades lower in the next few months.
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