Gold and Silver Realize the Fed Is Headed Toward Huge Mistake

"Insanity" is a word that comes to mind when contemplating a Federal Reserve that is looking to cut rates by 25 BPS, perhaps even 50 BPS, with the market at all-time highs, U.S. real GDP growing at 3.1% on a quarter-on-quarter basis and core CPI averaging close to 3.1% — far from the Fed's 2% target. 

On Wednesday, we have Fed Chair Jerome Powell presiding over the September FOMC meeting with the market convinced that the Fed will start easing rates after being on pause since last fall. The Fed has a dual mandate; full labor market employment and keeping inflation sustainable at 2%. It is the former that has had it dial up its recently dovish rhetoric.

According to a recent Labor Department release, the U.S. economy added about 900,000 fewer jobs than the initial estimate had suggested it would for the year through March. It is no mystery that President Trump wants lower interest rates, so he can pass through his fiscal plans by lowering the cost of U.S. interest expenses. This in combination with some August seasonality has given the Fed some weak labor market readings, that has led it to tilt dovishly as it fears this could be the start of unemployment rising well beyond 4.2%. 

The mistake is reading too much in the data as other measures of the labour market suggest real productivity is higher evidence by real retail sales and the initial claims data. The Fed's role is to primarily maintain financial market stability and be the lender of last resort during times of financial crisis as we witness in 2008 onwards. They have never been good at trying to pre-empt a crisis nor inflation for that matter. Doing so today, would be a grave mistake as the other side of the mandate has a much more sinister side.

It is debatable whether Trump's tariffs are causing inflation, given that most companies have held back passing through the higher costs onto customers, much to Trump's detriment, as he thinks exporters are eating the tariff bill. The real impact will be felt more in the second half, as demand was front-loaded into the first half of the year in lieu of the tariffs. 

The U.S. economy is showing signs of softening and only some areas are seeing tremendous growth, like AI, hardware and software infrastructure. With all of the capex spent by the Magnificent Seven, the proof will be in the pudding whereby capacity constraints like power and electricity will limit larger company take up of AI LLMs, as that adoption rate is already showing signs of slowing down. 

Investors will need to see real return on investment before placing a higher multiple on their futures earnings for now. With investors all in on the equities investment dynamic, one wonders if the pain trade is to the downside as the Fed ends up disappointing investors and maintains its course of being "data dependent," the more prudent approach.

The Fed will not like to be seen as being political. Trump has already been altering the mix of governors and members of the committee by appointing those that favor his dovish bias. Today, with U.S. national debt close to $37 trillion and U.S. interest expense north of $1 trillion, and U.S. economy adding $1 trillion every 100 days is no reason for the Fed to enable the government’s fiscal policy, as that was never its job mandate. 

It would serve the Fed to pay attention to what the bond market did last fall when it cut rates by 100 BPS in Q4 2024 — that the long-term yields rallied by 100 BPS — lest it desires a repeat of the bond market tantrum we witnessed last year. 

It seems gold and silver have already gotten the memo of what to expect on Wednesday night as investors have been rotating capital out of Treasuries into hard assets, as there is only one path for inflation it seems. Welcome to the new world order of stagflation, which cannot be fixed by cutting rates to aid jobs displaced by AI. It demands fiscal restraint and a global reset. Can the Fed surprise us?