We are not trying to provoke a recession, but it is certainly a possibility

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Now in his second day of testimony Chairman Powell continues to address the exceedingly high level of inflation and the Federal Reserve’s effort to curtail it. Currently, core inflation is running at three times the acceptable target of 2%, and the CPI inflation index at 8.6%.

Not since the 1980s has inflationary pressure been as consistent and hot as it currently is. While Chairman Powell suggested that the Federal Reserve was well aware of the challenges in front of them but they were prepared and able to bring inflation back to its 2% target. However, the facts speak for themselves, and those facts indicate that price increases have continued to accelerate over the last couple of months. The Fed’s prayers that some components of the supply chain issues will begin to unwind this year have not as of yet been answered.

What lies ahead is a extremely aggressive Federal Reserve which has raised interest rates for the last three consecutive FOMC meetings taking the target fed funds rate to
1 ½ - 1 ¾%. Fed members including Chairman Powell have signaled that these rate hikes will continue and the magnitude will be data dependent. Currently it is widely accepted that the July FOMC meeting will result in another ¾% rate hike. This will most likely be followed by another rate hike of ½ a percent at the September FOMC meeting.

According to Reuters, “Fed Governor Michelle Bowman on Thursday said she supported a 75-basis-point increase in July, followed by 50-basis-point increases in "the next few" subsequent meetings, a more aggressive path of rate hikes than most of her fellow central bankers currently contemplate.”

Their intent is to take core interest rates vis-à-vis the fed funds rate to approximately 3.5% by the end of the year. Even if the Federal Reserve raises interest rates 24% by the end of the year it will be difficult at best to have a profound and meaningful impact on the current level of inflation.

The Federal Reserve does not have the ability to combat inflationary pressures that are based upon supply side issues. While many of the supply side issues that arose were based upon pent-up demand after the pandemic, the new issues such as the war in Ukraine and the lockdown in China due to Covid-19 cannot be impacted by any actions of the Federal Reserve.

Chairman Powell acknowledged the limitations of the tools available to the Federal Reserve saying, "We don't have precision tools, so there is a risk that unemployment would move up, from what is historically a low level though. A labor market with 4.1% or 4.3% unemployment is still a very strong labor market."

Unquestionably, a tighter monetary policy will lead to a recession. It is not whether or not the United States will experience a upcoming recession, but when that recession will occur and how deep that recession will be.

This spilled over into the precious metals markets taking both gold and silver dramatically lower. As of 6:15 PM EDT gold futures basis the most active August 2022 contract is fixed at $1826.40. That is a decline of approximately $12 compared to yesterday’s closing price in New York. Silver lost 2.3% and the September contract is currently fixed at $20.925.

As interest rates continue to move higher it will continue to pressure the safe havens like the precious metals with one caveat. Interest rates need to be at least equal to the current level of inflation to have any deep and meaningful impact.

Wishing you as always good trading,

Gary S. Wagner - Executive Producer