On January 5, 2022, the Federal Reserve released the minutes of its December 2021 meeting, which was more hawkish than the interest rate statement, raising the possibility of raising interest rates early and mentioning shrinking tables for the first time. After the minutes were released, concerns about the Fed's further tightening of monetary policy increased, US bond yields rose rapidly and US stocks adjusted sharply. Yields on 10-year Treasuries rose sharply on expectations of the contraction, from 1.66 per cent after the close on January 4 to 1.78 per cent after the close on January 10. Us stocks fell rapidly, closing on January 5, with the s & p 500 down 1.94 per cent and the more interest-sensitive Nasdaq down 3.34 per cent. On January 10, Federal Reserve Chairman Colin Powell, who was nominated for a second term for four years, said at the confirmation hearing that the US economy is growing rapidly, the labor market is strong, and the Fed will prevent the persistence of high inflation. Affected by this, the three major indexes of US stocks collectively opened lower, and then the decline further widened, with the Nasdaq falling 2.7% at one point in intraday trading. During this period, gold did not fall sharply, but still maintained high oscillations, reflecting its ability to hedge against inflation and fluctuations in US stocks. Recently, Fed officials and voting directors have frequently released signals to raise interest rates and shrink the table in advance, which has intensified the volatility of the global market. Through a brief review of the last Fed contraction, this paper combs the background of this contraction to help investors understand the trend of gold prices.
After the outbreak of the financial crisis in 2008, the Federal Reserve adopted the QE policy for the first time. By 2013, it had implemented three rounds of QE, whose balance sheet expanded from $900 billion to $4.5 trillion. With the subsequent recovery of the US economy, the Federal Reserve announced in December 2013 that it began to scale back its bond purchases and raised interest rates in December 2015, embarking on the path of normalizing monetary policy. By comparison, after the novel coronavirus outbreak in 2020, the Fed's balance sheet expanded from $4.2 trillion to nearly $9 trillion; the Fed announced in November 2021 that it would begin to scale back its bond purchases and is expected to raise interest rates for the first time in 2022. It can be seen from here that the background of the two abbreviated tables is similar.
The final plan for the last reduction was put forward in June 2017, following the principles of passivity, gradual progress and predictability. The passive principle means that the Fed does not actively sell assets, but shrinks its balance sheet by stopping the reinvestment of some maturing assets, which has the advantage of having less impact on liquidity. The principle of gradual progress refers to the gradual increase of the scale from small to large, initially only $10 billion a month, and then gradually increased to $50 billion a month over a period of one year. The predictable principle refers to the advance and full communication with the market, the shrinking table is basically carried out when the market has expectations, and the impact on the market is reduced to a minimum.
The Fed began to slow down the rate of contraction in May 2019 and officially ended it at the end of September 2019. According to the minutes of the January 2019 interest rate meeting, Fed officials agreed to end the contraction by the end of the year. At its interest rate meeting in March 2019, the Fed formally announced a plan to gradually reduce the size of its table from $30 billion to $15 billion a month from May, and stop shrinking it at the end of September; however, it began to reduce the size of MBS in October to buy treasury bonds, up to $20 billion a month.
From October 2017 to September 2019, the Fed's balance sheet shrank from $4.5 trillion to $3.8 trillion. It was reduced by nearly $700 billion in two years, accounting for 15.6 per cent of the pre-scale scale.
The background and time node of the Fed's shrinking table.
On January 5, 2022, the Federal Reserve released the minutes of its December 2021 meeting. In terms of employment, the minutes of this meeting show that the United States is facing a relatively serious labor shortage and excessive wage growth, the employment vacancy and voluntary turnover rates remain at historical highs, and the recovery of the labor market is relatively clear. gradually approaching the Fed's maximum employment target, and even some officials believe that full employment has been achieved. In terms of raising interest rates, the minutes of this meeting raised the need to raise the federal funds rate earlier than previously expected, based on the economy, the labor market, and inflation; and even some participants considered it appropriate for the Fed to raise the federal funds rate's target range before the maximum employment rate was fully achieved. In terms of contraction, this is the first time that the Fed has discussed the issue in its minutes, and the vast majority of participants believe that it is appropriate to start the contraction at some point after the target range of the federal funds rate is raised for the first time. With regard to the epidemic situation, the minutes of this meeting pointed out that the O'Micron mutant strain or aggravating frictions such as labor shortage and supply-side constraints will continue to pose a downside risk to economic activity and an upward risk to inflation, but it will not change the trend of economic recovery in the United States.
The minutes of the Fed's December 2021 meeting show that officials have had a wealth of discussions around the issue of shrinking the table, adding to fears that the Fed will turn the hawk further. The two key words "balance sheet" or "shrinking table" are mentioned many times in the minutes, and it is revealed that this round of contraction may be earlier and faster, mainly due to the rapid recovery of the US economy after the epidemic and strong demand in the job market. Inflation continues to rise higher than expected.
On January 7th the U.S. Bureau of Statistics released non-farm data for December 2021, with a mixed overall performance. Non-farm payrolls increased by 199000, underperforming the expected value of 400000 and the previous value of 249000, the smallest increase since January 2021. The unemployment rate and wages performed strongly, with the unemployment rate of 3.9% in December 2021, better than the expected value of 4.1% and the previous value of 4.2%, which continued to be the lowest since February 2020, while wages rose 4.7% from a year earlier, exceeding the expected rise of 4.2%. The strong unemployment rate and the rapid rise in wages highlight the trend that employment is improving and inflation will remain strong.
The US unemployment rate fell to 3.9 per cent in December 2021, outperforming expectations of 4.1 per cent and previous values of 4.2 per cent, the lowest level since the outbreak and very close to the Fed's forecast of 3.5 per cent unemployment at the end of 2022. The performance of the unemployment rate shows that the US job market is infinitely close to full employment, reaching and exceeding the Fed's estimate of full employment (fixed at 4.0% by the Fed), while offsetting the negative impact of lower-than-expected non-farm payrolls. The labor force participation rate in the United States rose to 61.9 in December 2021, stronger than the previous value of 61.8. The decline in the unemployment rate with the increase in employment participation rate indicates that the recovery of some labour markets is better than that shown by the data, and the decline in unemployment can be directly understood as the result of an increase in employment. The average hourly wage rose 4.7 per cent year-on-year in December 2021, better than expected, indicating a tight labour market on the one hand and rising wages on the other, and inflation will remain strong.
Strong unemployment and rising wages in the US in December 2021 have raised expectations that the Fed will raise interest rates ahead of time. After the release of the non-farm data, the swap market now expects a 25BP rate hike in March of about 88 per cent, with a higher probability of a first rate hike in May. The Fed's chances of raising interest rates in March are 90 per cent, up from 80 per cent on January 5, according to federal funds rate futures. Moreover, from the fed's point of view, the current labour market is not its biggest focus, but has been replaced by a sharp rise in inflation; in November, US CPI rose 6.8 per cent year-on-year, a 40-year high. In order to curb the continued rise in inflation, the Fed will inevitably move towards raising interest rates or even shrinking its table in 2022.
For the Fed's monetary policy, the end of QE in March is basically certain. In terms of interest rate hike policy, the possibility of the Fed starting to raise interest rates in March has greatly increased, and the interest rate hike cycle will begin in June at the latest. Under the circumstances that the job market continues to improve and the unemployment rate basically meets the Fed's expectations, the trend of inflation is the core factor affecting the timing of the Fed's interest rate hike. With regard to the contraction policy, the Fed minutes have clearly discussed the necessity and feasibility of the contraction, and Fed officials have also repeatedly stressed the necessity of the contraction. The market expects the Fed to put the contraction on the agenda after raising interest rates twice, and will begin to signal and implement the contraction policy in the second half of the year.
The volatility of gold price increases and may hit the high in 2020.
The overall trend of gold prices weakened and did not show an obvious trend in 2021, mainly because the US economy is in the stage of recovery. however, due to the uneven global economic recovery, increased volatility in energy prices and structural problems in the US domestic supply chain, the US economy swings between "recovery" and "stagflation". The contradiction between the regulation of the US government and the Federal Reserve and the current economic situation has prevented precious metals from coming out of a smooth decline.
Affected by the epidemic, the global supply chain continues to be disrupted and the market is overflowing with liquidity, and inflation in major economies continues to rise and hit an all-time high. The Federal Reserve has started Taper, in November 2021 and expects to end QE, in March 2022, and interest rate hikes and shrinks are expected to advance significantly. Under this premise, the inflection point of global liquidity is now in place, which will have a huge impact on global risky assets in 2022; the dollar index will remain strong and put pressure on gold. But instead of falling sharply after the Fed's recent release of hawkish expectations, gold fluctuated slightly around $1800 an ounce, supported by its safe-haven nature. At present, the main index of US stocks is still at historical highs, but the volatility has increased significantly, and it is bound to fluctuate dramatically in 2022 under the expectation of the Fed's shrinking schedule. Gold will become an ideal hedge against inflation and risky assets such as US stocks. We expect that in 2022, when the negative expectations of the Fed tightening are gradually exhausted, the safe-haven nature of gold will emerge, the volatility of gold prices will rise, volatility will increase, and is likely to hit highs in 2020.
