As we have already reported, Janet Yellen testified two days ago to the Senate Banking Committee. Yesterday the Fed's chair submitted identical remarks to the Committee on Financial Services, U.S. House of Representatives. What we want to analyze today are, thus, her question-and-answer sessions from these two days and their implications for the gold market.
Following her testimonies, Yellen was asked many times about the inflation in different contexts. On wages and inflation, two days ago she answered:
"I don't see any evidence of that (inflation heading above 2 percent) ... we need to be forward looking... We do see that the labor market is improving and we are getting closer to our goal of maximum employment. It's important to remember that monetary policy is highly accommodative."
It is an important hint: the Fed does not see inflation heading above the target. All that remains is the belief that disinflation will be transitory. Just forget about the harsh present reality, we have to be forward looking. It is a bit ironic that a Keynesian economist, who should be repeating all the time that in the long-run we are all dead, says that the future is bright. It seems that the philosophical position depends on whether the Fed should introduce or give up a highly accommodative policy.
The next answer, from today' session, is even more bullish for the gold prices.
"We think that inflation is going to move lower before it moves higher for exactly the reasons you cited: import prices have been falling in part because of the dollar, and declining oil prices have had a very major influence ... We do think that the effects of these factors will be transitory and, especially with an improving labor market, that we expect inflation over the medium-term, the next two or three years, to move up to our 2 percent target."
It seems that Fed adopted a rather uncommon definition of 'transitory'. Usually it means short-lived, however for Yellen inflation may move up just over the next two or three years, after the 'transitory' factors have ceased to influence the economy. So, how does this affect the timing of the Fed's hike? Well, Yellen gives an answer:
"Before beginning to raise rates the committee needs to be reasonably confident that over the medium-term inflation will move up toward its 2-percent objective. I don't want to set down any single criterion that is necessary for that to occur. The committee does look at wage growth. We have not yet seen - there are perhaps hints - but we have not yet seen any significant pick-up in wage growth."
When will the Fed be reasonably confident about the future dynamics of inflation (if it is possible at all)? Just imagine Yellen's answer. Uhm. Good question. Fed does not have any single criterion to measure an inflation, but we can look at wage growth. Yes, I said a moment ago that "wages tend to be a lagging indicator of improvement in the labor market", but we can use it to assess future inflation. It does have perfect sense, we have to be forward-looking.
Let's move joking aside. The Fed makes an interest rate hike dependent on the level of inflation, while inflation depends on wage growth. So, what is Yellen's opinion about the labor market and future wage growth?
"(The U-6 measure of unemployment) is a much broader indicator of underemployment or unemployment in the U.S. economy ... It definitely shows a less rosy picture than U-3 or the 5.7 percent number and I did mention that we don't at this point, in spite of the fact that the unemployment rate has come down, don't feel that we've achieved so-called maximum employment in part for these very reasons ... Labor force participation has come down ... I don't expect it to move up over time, but I do think a portion of the depressed labor force participation does reflect cyclical weakness in that in a stronger job market more people would enter."
It does not sound too optimistic. As we have pointed out, looking from the broader perspective, like the U-6 measure of unemployment does, the labor market is far from full recovery.
To sum up, the Fed makes an interest rate hike dependent on the level of inflation, while inflation depends on wage growth, which has not recorded any significant pick-up in wage growth. It means that the Fed signals no rush to raise rates. Therefore, we interpret Yellen's spontaneous answer sessions as bit more bullish for the gold prices than the carefully prepared testimony. Taking under account gold prices after Yellen's testimony, the market could think similarly and the long-term outlook for gold remains favorable. Based on the technical developments in the gold charts, though, the short-term outlook does not have to be as bright.