Gold Range Bound, Awaiting FOMC Decision

20-Sep (USAGOLD) — Gold remains well contained within the recent range, awaiting the Fed’s decision tomorrow regarding further accommodations. The FOMC meeting that commenced today was expanded by an additional day to “allow for a fuller discussion,” which probably more accurately translates into chairman Bernanke needs more time to get dissenters, Fisher, Plosser and Kocherlakota, in-line behind new measures.

Getting the dissenters to at least concede that risks to growth have increased dramatically in recent weeks should be fairly easy, given the fact that no new jobs were added in August and confidence has plunged. Even the Fed itself has negatively revised its growth outlook and last week’s release of the Fed report on household balance sheets through Q2 showed some pretty devastating declines in net worth that are expected to continue through Q3. Today’s negative revisions by the IMF to both global an US growth forecasts for this year and next, tip-in the reality that everyone seems to already be aware of, that the US is slipping back toward recession. And that in turn, is weighing heavily on global growth prospects.

Bernanke might also argue that with the economic slowing, price risks have moderated. Additionally, further stimulus on the fiscal side — in the form of President Obama’s jobs bill — has very little chance of advancing. It’s up to the Fed to act, or there will likely be a double-dip.

Undoubtedly, events unfolding on the other side of the pond are factoring heavily into the FOMC’s discussions as well. The Fed’s agreement last week to basically provide unlimited dollar liquidity to Europe is an ominous acknowledgement to the direness of the situation on the Continent. Market analyst John Mauldin wondered this week, what “is the Fed doing, giving essentially unlimited funds to European banks? What are they seeing that we do not?” His conclusion seems to be that the Fed, in conjunction with the ECB, SNB, BoE and BoJ, are seeking to build a firebreak against a catastrophic Lehman-type default. If the answer for Europe is more liquidity, the likely answer for US banks is to bolster liquidity here as well.

With short-term interest rates at 0% and the 10-year yield trading below 2.0%, the Fed really has limited options at their disposal. They can pump the liquidity domestically via the traditional means of quantitative easing, buying shorter-dated securities, confirming their commitment to keep short-term rates exceptionally low into mid-2013. However, after the previous QE1, QE-lite, QE2 and the ongoing QE2.5 operations, that strategy has proven to be largely ineffective. That leaves an attack on the long-end of the curve as a new potential ‘twist’ to QE; selling their shorter-dated holdings and buying 7- to 10-year notes to twist the yield curve and bring down longer-term rates. While this would arguably drive down rates on longer-term business loans and mortgages, there’s still a huge problem with getting businesses and people qualified for these loans.

There is additionally the chance for even more explicit guidance than the “mid-2013″ offered up last month. They could also stop paying the admittedly paltry 0.25% rate that they are currently giving on reserves, in the hope that it might force some of those funds into circulation. The latter strikes me as having limited value.

The most likely scenario is that the Fed will announce some plan along the lines of Operation Twist to extend the maturities on their balance sheet. That is largely baked into the cake at this point, so if the Fed meets expectations, I wouldn’t expect any kind of big market reaction. But, I would also say that it wouldn’t be detrimental to gold’s long-term uptrend. On the other hand, if there is additional guidance, or something even more accommodative comes out of the meeting, the dominant uptrend in gold would likely start to re-exert itself.