27 June 2022
By Georges Lequime
On June 16, the FOMC raised the fed funds rate by an aggressive 75 bps to 1.625% (the midpoint of the 1.50%-to-1.75% target range). Such a large hike last happened in November 1994, marking only its second occurrence in the past 33 years. This was a big and bold policy move in response to a worsening inflation situation.
So, where do we go from here? The ‘dot plot' in the Summary of Economic Projections (SEP) provided a powerful clue. All 18 participants had at least a 3.125% fed funds forecast for the end of this year. The median is now 3.375%, representing a further 175 bps of tightening from the current 1.625%. More rate hikes are projected next year by almost all participants.
The more aggressive tightening path does take its economic toll. The median projection for real GDP growth this year and next was lowered to 1.7%, slightly below potential of 1.8%, and below the previous projections of 2.8% and 2.2%, respectively. The unemployment rate eventually rises above 4% (4.1%) by 2024, 0.5 ppts above the prior forecast. Meanwhile, inflation is projected to come under control quickly, back to about the mid-2% range by next year (2.6% total, 2.7% core) after ending this year at 5.2% for the total and 4.3% for the core.
The bottom line is that America’s inflation problem has become broader and more persistent. In quick response the Fed intends to tighten more aggressively. Unfortunately, this also carries with it an escalating risk of precipitating a recession, with real GDP possibly grinding to a near halt (averaging just 0.3% annualized) through the turn of the year.
The gold price is behaving as expected versus the broader market, acting as a solid haven investment in the face of market turmoil. Even though bullion prices have dipped a little this year, they have significantly outperformed other major asset classes such as stocks, bonds, and cryptocurrencies, which have all been under pressure. The strong dollar and rising interest rates are keeping a lid on the gold price, though. With uncertainty around the outlook for inflation, sentiment towards gold and silver shares remains very weak with the current market expectations being that inflation will return to the mid-2% range in 2023 at the same time as interest rates remain high (i.e. positive real interest rates). We calculate that the shares are now already discounting a 20-25% lower gold and silver price. We continue to highlight the risk of higher inflation for longer, which supports a higher gold price outlook going forward. Right now, with the gold and silver shares already pricing much lower metal prices, we continue to believe that, on a risk-reward basis, a 50% weighting towards precious metals in the Fund is justified.