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Friday, August 11, 2006

FED Pause and Inflation

On the Poly site we had a discussion about how much of the POG was monetary and how much was a crisis premium for world events. I believe that the recent reaction of gold to the FED announcement of a pause in interest rates and to the Lebanon crisis and the terrorist plot in the UK all seem to indicate that the primary driver in the POG is monetary, meaning fiscal events that have primarily a monetary effect as opposed to events that are significantly crisis effects.

Both the POG and the price of oil have been trending downward since the FED announcement. This is consistent with investers recognizing that a lower FED interest rate will allow the market rate to settle and business to increase sopping up excess currency.

It seems clear now that when the FED increases interest rates it creates a condition exactly the opposite of what it states is its intention.


Blogger Henry Meers said...

Gold has been in a down-trend for a lot longer than that. The price may reflect monetary events, but we have to broaden the definition in times like these. When the U.S. was on the gold standard, all the benefits of owning the metal were part of the currency. Now, two key components of gold in a crisis, portability and divisibility are missing from the dollar, because people cannot be sure it will hold its value or be readily accepted some places. This, of course, has always been the risk of converting your gold into paper.

Otherwise I agree with you and am awaiting the crisis that always comes after the Fed tightens, since it always overdoes things, sort of like the animal a boa constrictor shallows: you don't know what it is, but you can see it is in there. Maybe, Bernanke let go because of the international situation, as did Volcker in the Mexican crisis, we just don't know why yet.

5:33 PM  
Blogger ebreen said...

I think gold is down because there is a consensus that the Fed has already raised rates to a point that will produced an increased slowdown. I think the market expects more FFR increases after the election. I think the smart money bid up share prices before the pause and took profits at the pause. I don't think the market has any idea that lower rates and increased growth will mop up the money supply. That insight is narrowly understood only on pages like these. The market and the gold price is discounting inflation based on continued FFR inicreases at the end of the year. Look for minor gold price rebound when CPI comes in higher than expected next week, then look for some decline as market understands that persistent inflation will lead to FFR increases after the election. Gold will trade sideways to down until it eventually breaks out later this year or early next.

8:33 PM  
Blogger Dick Fox said...

Ed: I don't think the market has any idea that lower rates and increased growth will mop up the money supply. That insight is narrowly understood only on pages like these.


Some of these things are not understood explicitly but the reaction creates the same condition. The initial reaction is that the FED action will increase business prosperity and so without thinking of the monetary effects businesses automatically increase activity.

If the FED reacts negatively to the coming bad news on inflation POG should spike.

My point is that the crisis premium in POG seems less than most give it credit. POG is still monetary.

4:45 AM  
Blogger ebreen said...

Dick in predicting the market reaction you have to weigh not so much the increased inflation but the markets expectation of the effect of the Feds reaction to the increased inflation and how the Feds reaction will effect the market in the future. So, the CPI comes in higher than expected...the market caculates that the fed will resume raising rates...(watch change in the interest rate futures for the change in % prediction of future increase) calculates further that those future rises will increase the pace and severity of economics slowdown...chance of recession increases...Market calculates that declining growth will crash commodity and energy prices, reduce earnings of public companies...and eventually reduce inflation. So, the issue is about the fed reaction not the actual inflation. Market does not discount mark up through growth. Market expects keynesian reduction of inflation from attacking growth, classic phillips curve. What does gold do? it goes down, it goes sideways, it goes up next year...probably meanders in its current 600's trading range and drifts toward 700. If Fed convinces the market that it will not pause in the face of increasing inflation numbers then gold will rise dramatically even thought the pause would mop up the liquidity and bring the gold price back down in a year or so. Just predictions and thoughts...pretty hard to predict how wrong consensus will evolve.

7:52 AM  
Blogger ebreen said...

Dick, in above post I said if market predicts that Fed will not pause then gold will go up...I meant that if market predicts that the Fed will continue to pause in face of increased inflation numbers then gold would go up. Sorry, no edit function here to correct the typo.

7:55 AM  
Blogger Dick Fox said...


In the short run it might be true that a pause by the FED in the face of future inflation could cause the POG to climb, but as reality overwhelmed perception the POG would decline. But if the FED pauses and makes a case that inflation is over and that any inflation in the numbers is not the real situation, then the perception of higher inflation would be dampened.

I still believe that a continued pause by the FED will continue the decline in the POG.

We shall see.

5:26 AM  
Blogger n-tres-ted said...

Dick and Ed,

I think there is common ground in what each of you state, although you point to diverging outcomes. The common ground is that each participant in the markets will act in his self-interest as he perceives it to be. Those who follow Keynesian analysis (and many do who manage bonds and other investments) will think a pause will allow greater price inflation to occur. When they see a pause in rate hikes, they will sell bonds, buy gold, etc. Others who see the pause will detect a prospect that returns on business investment will be better and will sell gold, invest in equities, etc. If there are more who agree with this latter point of view of self-interest, the Keynesian-driven investors will see gold declining and equities rising, and will modify their analysis accordingly (probably on the basis earlier rate hikes are "doing their job"). Presently, the FFR is so high, making credit so expensive for mid and small business, there may be too few business deals that make investment sense. If that is the case, as when tax rates are too high, the stagflation result may be the outcome.

10:18 AM  
Blogger Dick Fox said...


I believe that oil will follow gold in the downtrend and this will be the indicator that BB needs to justify another pause. While I agree that the CPI will continue to increase the price of oil is something that is tracked daily by the media. The equation is not just equities v gold.

10:33 AM  
Blogger ebreen said...

For all you inflaton watchers out there it is almost that time of month again. Get out your rear view mirrors and focus in to where we have been. The CPI for July will be released on Weds. The CPI for June, released last month was 4.3 YoY. For forward lookers, the GVM, six months ago predicted that the high range of the CPI for June would be 4.3. The GVM prediction for the National CPI-U for July will be 4.6%. Not a happy fed number!

8:57 PM  
Blogger ed hanson said...

Ed B

The cpi-u numbers are out. Which number does the GVM point to?

compound annual rate 3-months ending July 2006 ---- 4.5%


unadjusted (seasonal) 12-month ending July 2006 ---- 4.1%


a different flavor?

10:48 AM  
Blogger ebreen said...

Ed H, the GVM prediction is for the YoY National CPI-U, that would be the 12 mo. unadjusted number of 4.1. So the GVM was high. However, it is impressive to me that the prediction was made in January and it is right on for the trend. What do you think the consensus of economists was last January about what the CPI number for July would be? The consensus for the July number was 4.6, but the consensus was formed in the last 30 days. David Woods comment on another thread is very astute with regard to how these YoY numbers interact with the same month of the previou year. That observation might make good cause for an adjustment (with'n the range of error). I am confident that the GVM is calling the trend better than any other statistical prediciton model. I am intrigued about how to make the monthly predictions more accurate through adjustments to the six month predicition with information gained at 5 months through 1 month, that may allow further adjustment to reduce the error.

9:06 AM  
Blogger ed hanson said...

Ed B

If the air needs to be cleaned, I did not mean a gotcha on the GVM. I did not know which measure of the CPI-U it was predicting. I remain intrigued about the value of the GVM.

I would go slow about major adjusstments to the GVM. For one, the current CPI-U may be adjusted upward when the final figure is made, and two, did not the GVM predict a flattening or reduction in the index in the coming months. Perhaps a bias rating of the GVM can be developed, based on short term economic factors.

This low side index, if correct, may show that some actions of the world CB's may have more immediate effects on inflation than previous thought. But too, this may be a matter of world wide supply-side fiscal policy improvements, a category which has been missing from comment since our loss of Jude. I have not seen much analysis of such since the Eastern European changes to a flat tax.

Ed H

5:17 AM  

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