Other Potential Results of Quantitative Tightening by the Federal Reserve

The Federal Reserve’s monetary policy, comprised of aggressive rate increases coupled with balance sheet shrinking, is aimed at achieving price stability through lower inflation. The Federal Reserve assumes that it can effectively reduce inflation without creating a recession. While this is a possible outcome, achieving this goal will be extremely difficult at best and impossible at worst.

The Russian invasion of Ukraine has had a profound impact on commodity prices, supply chains, inflation and a sharp contraction in global growth. The impact of the Russian war is that the Federal Reserve can only affect core inflation, which does not lead to a significant real reduction in inflation or economic contraction. Thus, a key risk to the global economy is the possibility that inflation will remain persistent and high along with contraction in economic growth, the definition of stagflation.

Currently, inflation worldwide remains extremely high. Today the European Union reported that inflation reached a new record in June. Headline inflation in Europe was 8.6% year-on-year, exceeding the level of inflation in the United States, which is at 8.3% (CPI reading for May). Inflation in advanced economies is currently at its highest levels recorded in the last 40 years.

Global growth recovered to 5.7% in 2021; however, most of the global growth that occurred in 2020 and 2021 was supported by global fiscal and monetary policy accommodation. With this accommodation now over, economic growth is expected to contract to 2.9% in 2022. More alarming is the high probability that global growth will continue to contract little changed in 2023.

Today, the Brookings Institution released an in-depth study on how “today’s global economy is eerily similar to that of the 1970s.” This study acknowledged that “the global economy is in the midst of a sudden slowdown accompanied by a sharp rise in global inflation to multi-decade highs. These developments raise concerns about stagflation, the coincidence of weak growth and high inflation, similar to what the world suffered in the 1970s.

This study locates that the current supply shocks occurred after prolonged accommodative monetary policy led to pent-up demand coupled with the recent global supply shock in food and energy costs due to Russia’s invasion of Ukraine. According to the study, the global economy faces similar challenges to the oil shocks that occurred in 1973 and 1979-80. The study concludes that, as in the 1970s, the world economy could be pushed into a period of stagflation.

There are multiple possible outcomes from global central banks and Federal Reserve monetary tightening. Its intended goal is to successfully reduce inflation and soft economic landing simultaneously. While this is the desired result, it will be the most difficult result to achieve. There is a real risk that their actions will lead to high and persistent inflation combined with economic stagnation.

If the world economy enters a period of stagflation, this will certainly create a strong bullish backdrop for gold prices. This can be seen in today’s price action in gold. Gold futures traded at a low of $1783.40 last night and are currently pegged at $1812.12, signaling a dynamic pivot and possible key reversal. We could see market participants focus on the real possibility that the monetary policy of central banks globally will lead to stagflation rather than their intended goal of reducing inflation.

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Disclaimer: The views expressed in this article are those of the author and may not reflect those of Kitco Metals Inc. The author has gone to great lengths to ensure the accuracy of the information provided; however, neither Kitco Metals Inc. nor the author can guarantee such accuracy. This article is strictly for informational purposes only. It is not a solicitation to make any exchange of commodities, securities or other financial instruments. Kitco Metals Inc. and the author of this article accept no responsibility for loss and/or damage arising from the use of this publication.

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