Coming Home to Roost: The Fed’s Inflationary Policies

Whether the current higher inflation levels in the US have been the Federal Reserve Bank’s intended policy all along is perhaps a moot point. We have to assume that although the central bank may have been working towards higher inflation levels, they are currently running above anticipated percentages.

Certainly the effective pumping of liquidity into the US economy to protect it from the depredations of the Covid-19 pandemic will, in hindsight, have led to an inevitable inflation rise.

But, in mitigation, one doubts that the Fed had foreseen quite how high, and how prolonged, the inflationary trend would be once it started to get under way.

The past week’s Consumer Price Index (CPI) reading has certainly brought the consequences home for all to see. It suggests an annual inflation rate of 6.2% – and this may well be an underestimate as the 0.9% monthly rise could even be pointing to a likely higher annual rate approaching 10%.

That is certainly the kind of price inflation already being seen by the American general public in its day-to-day shopping for energy, food and other staples. The higher levels also look to be borne out by the Producer Pricing Index, which is trending even higher than the CPI at over 8% year-on-year according to the latest figures.

Certainly the announced Fed policy had been suggesting a higher inflation rate to be desirable over and above the sub-2% levels that have been apparent over the past few years.

But one doubts that the central bank had foreseen the soaring levels we have just been encountering. Once inflation starts to take hold it can be hugely difficult to control.

The current inflation rate, if it persists, is certainly providing a major policy headache for Fed chair Jerome Powell. He has been persisting with an ultra-low interest rate policy to help the economy to grow and unemployment levels fall to the “maximum” percentage level of around 3.5% – around the pre-pandemic figure.

This has come down, but still not quite enough, which makes for quite a dilemma for the Fed. Should it raise interest rates sooner, rather than later, to try and bring inflation under control, or continue with minimal interest rates until unemployment falls to the target level?

The higher than anticipated CPI level of the past week has, on reflection by the markets, led to a significant price boost for gold and silver in particular, which they have managed to hold on to for the most part over the remainder of the week.

Gold thus managed to end the week of November 12th in the $1,860s and silver over $25. This was a nice leg up for both of them after recent disappointing performances.

In my view, both gold and silver will now consolidate around these levels before potentially making another upwards move with gold challenging $1,900 and silver $26 before the year end. Should that occur, it might pave the way for gold regaining $2,000 in the first half of next year.

Silver’s likely strength will depend perhaps more on industrial demand than movement along with the gold price as has been the case in the past. However, both elements could contribute to the metal’s price strength moving forwards. Even so I don’t see the silver price rising much above $27 in the short-to-medium term.

Platinum and palladium also saw price rises with the former doing better than the latter in percentage terms. The price gap between the two has narrowed, suggesting that price parity between the two most heavily traded platinum group metals (pgms) might be reached in the medium term after palladium had surged hugely ahead of platinum earlier in the year.

In retrospect, global central bank largesse will have inevitably led to inflation – the surprise may be that it seems to have taken quite so long to become apparent.

While I consider the US economy to be too strong and thus able to ward off what could be described as hyperinflation, current levels could still get worse before they begin to get better; that is with or without the Fed raising interest rates, although it will be under strong pressure to do so.

I have said before that the Fed is correct in describing some of the make-up of the current inflation rises as transitory and these will fall away as the pandemic is overcome. But this will take time to exit the system and we could well see higher levels in the meantime.

Even if the Fed does raise interest rates these increases may be too small to combat a perhaps prolonged period of negative real rates. This could lead to a further decline in dollar purchasing power and thus gold price strength.

Some observers see the dollar as overvalued. I am not so sure given equally strong, or even greater, inflationary pressures affecting many competing currencies as well.

Even so, purchasing power degradation could lead to a stronger gold price, particularly if we see equities and bitcoin start to come off their recent high points.

Gold, in my opinion, thus remains an excellent wealth protector.

by Lawrence Williams

Lawrence Williams

Lawrence (Lawrie) Williams is a highly regarded London-based writer and commentator on financial and political subjects, specializing in precious metals news and commentary. He graduated in mining engineering from The Royal School of Mines, a constituent college of Imperial College, London. He has contributed articles on precious metals to the Financial Times, Sharps Pixley, US Gold Bureau and Seeking Alpha among others.

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