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May Market Minute

May Market Minute

As largely expected, the Federal Reserve increased the fed funds rate an additional 25 basis points to a range of 5.00% to 5.25%. The overriding message was we will now wait-and-see.

The main change in the statement from the March meeting statement was the removal of the sentence: The Committee anticipates that some additional policy firming may be appropriate in order to attain a stance of monetary policy that is sufficiently restrictive to return inflation to 2 percent over time.

And replaced with: In determining the extent to which additional policy firming may be appropriate to return inflation to 2 percent over time, the Committee will take into account the cumulative tightening of monetary policy, the lags with which monetary policy affects economic activity and inflation, and economic and financial developments (bolding added).

In the press conference Powell then explained that this change means that they no longer anticipate that rate hikes will take place at future meetings but instead will be driven by incoming data meeting by meeting. Hence, the wait-and-see message.

This week’s increase was the 10th increase in the fed funds rate since March 2022 for a total increase of 5% in just over a year. Inflation, although down from 2022 highs, remains well above the Fed’s 2% target, but the rapid increases are exposing vulnerabilities in the economy, especially in the financial sector.

Regional Banks in Freefall

The banking problems are not over yet. Regulators seized First Republic and struck a deal to sell the bulk of its operations to JPMorgan, heading off a chaotic collapse that threatened to reignite the recent banking crisis. JPMorgan said it will assume all of First Republic’s $92 billion in deposits—insured and uninsured. It is also buying most of the bank’s assets, including about $173 billion in loans and $30 billion in securities. As part of the agreement, the Federal Deposit Insurance Corp. will share losses with JPMorgan on First Republic’s loans. The agency estimated that its insurance fund would take a hit of $13 billion in the deal. JPMorgan also said it would receive $50 billion in financing from the FDIC (WSJ, 04/30).

First Republic, the second largest bank in US history to fail, lost $100 billion in deposits in March following the collapse of Silicon Valley Bank. It received a cash inclusion of $30 billion from America’s largest banks that kept it afloat for several weeks.

Shares of major U.S. regional banks fell further on May 2. Investors are still concerned that the crisis started by the closure of Silicon Valley Bank and Signature Bank in March could engulf other mid-sized lenders. Shares of PacWest Bancorp (PACW.O) tumbled -30%. Other notable names that sold off were Western Alliance (WAL.N) -25% and Metropolitan Bank (MCB.N) -21%.

The Role of the US Dollar

The discussion below is taken from the March 31stGold Monitor on the future of the US dollar as a reserve currency. The US dollar is frequently discussed in the Gold Monitor as it is a key determinant of the gold price.

There has been a significant increase in articles and reports on the future of the US dollar as a reserve currency – notably in the wake of US financial sanctions on Russia after it invaded Ukraine. The unintended consequences of US sanctions include a perceptible shift of dollar reserves into non-dollar reserves by some (neutral/non-western) countries, including into gold and non-western currencies such as the Chinese yuan. It’s not sure the US could have prevented this shift unless it chose not to use financial sanctions in its efforts to force Russia to abort its invasion of Ukraine. Regardless, the long-term reality is that as China becomes an increasingly more dominant economic and political power, the renminbi is destined to become a more important invoicing currency (for trade with China, in the first instance) and potentially a more important reserve currency.

The long-term trend of foreign exchange reserves held in US dollars is mildly downward, which is expected when new economic powers – China, India – are emerging, and their respective currencies become more useful invoicing currencies in global trade. But replacing the dollar as the world’s primary reserve currency will be a slow process. A global reserve currency requires open capital markets that are globally accessible and free of political interference and restrictive legislation. The renminbi is a heavily controlled currency, making it unsuitable for other than an expedient invoicing currency (i.e. for trade between Russia and China) – at least for now. It is unlikely that the communist government in China will allow laissez faire capital markets to flourish (something that usually comes only with democracy).

Gold Holding Recent Gains

The gold price is flirting with breaking out to new highs. There are many positive factors in the current economic/financial environment that could drive the gold price higher. A few key factors are:

The Fed is most likely at the peak of interest rates increases for this cycle; geopolitical issues will continue to encourage safe-haven demand; central bank demand is at record levels; and the US dollar is likely to continue weakening.

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