Will the Fed Push Gold and Crypto Up by Raising its Inflation Target

4/19/2022

Economy

0 min read



Image: Marco Verch (Flickr)

Allianz Economist Explains His Thoughts on Gold and Crypto’s Future

Muhamed A. El-Arian is the Chief Economic Advisor at Allianz, (Allianz owns PIMCO). He said in an interview on CNBC he believes the Fed may have to raise its inflation target to 3%. The Fed’s current and ongoing inflation target is 2%. Recent inflation reports show YOY inflation at 8.5%. The Allianz economist sees prices increasing within the various asset classes that are generally seen as inflation hedges. This is why he is bullish on gold and cryptocurrencies.

Gold and cryptocurrency prices would increase if the Federal Reserve were to lift its inflation target as it engages in a prolonged fight to bring down consumer prices, economist Mohamed El-Erian told CNBC on Monday (April 18). “They both go higher in a world like that,” he said, referring to the notion that the Fed may need to increase its long-term inflation target to 3% from 2%.

“What will force them to change their target is the recognition that by being so late, they can’t get to that target and their credibility is threatened,” said El-Erian. “They will also worry that by hitting the brakes too hard, they may push this economy not just into a short-term recession, but into a longer term recession.” Controlling inflation and calming markets while orchestrating price stability is tricky. El-Arian believes that the markets will view the Fed as being more credible if they set and attain a 3% target rather than fail at a 2% target while crippling the economy longer term.

Currently, the FOMC Fed Chair Jay Powell is working to tamp down the rise in prices which is due to tight labor markets, supply chain issues, higher fuel demand with less fuel production, an increase in money supply, and an overall expectation of higher prices. Inflation in March beat a 40-year high at 8.5% year-over-year. The last time price increases were so rampant, Ronald Reagan had just begun occupying the oval office.

Last month the FOMC began what is being viewed as an interest rate-hike cycle when it raised the Fed Funds rate 25 basis points from a range of 0% to 0.25%. It has also begun tapering and will soon shrink its balance sheet which has the impact of taking cash out of the market which makes money more expensive (interest rates).

Impact on Gold and Crypto

Gold is considered a safe haven when there is uncertain global stability or a risk of higher prices. With the accelerated money creation attributed to the pandemic and the Russian invasion of Ukraine, gold prices have risen about 9% this year, trading at $1,960 per ounce. In contrast, bitcoin has decreased in value by 16% to $41,300 and ether has lost 21% to trade at $2,900.

Is crypto as good of a diversifier as precious metals? The Allianz economist said, “The concern for the crypto people is that this decline is happening at a time when gold is up and hitting almost $2,000,” He continued, “The big argument for crypto is it’s a diversifier — at a time of inflation, it is attractive.” But crypto hasn’t worked as a cushion recently, he said. “And that’s because crypto, unlike gold, benefited enormously from all the liquidity injections.

The way El-Arian reads the increase in gold and decline in crypto prices is there is a tug of war between the recognition that liquidity is going out from the system as a whole and attractiveness as a diversifier. He explained the liquidity element is winning out.

The Fed’s Inflation Target

El-Arian, as mentioned earlier believes that a credible target will comfort the markets compared to one that the Fed is less likely to attain soon. “What will force them to change their target is the recognition that by being so late, they can’t get to that target and their credibility is threatened,” said El-Erian.

El-Arian told CNBC he would expect gold and crypto prices to rise if the Federal Reserve were to raise its inflation target to 3%.

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