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Fed minutes: Hawkish tone, gold rebounds, and hedge fund concerns

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2023-11-22

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The Fed's latest policy meeting minutes were predictably a touch hawkish—indicating rates would stay higher for longer. One commentary described it as 'a slight tightening bias.' However, gold bounced back over $2,000 an ounce on Comex, gaining 1% on the day.

The Comex front-month price settled just over $1,998 an ounce, having touched $2,009 an ounce in trading before edging back over the $2,000 level in early Asian dealings on Wednesday morning.

US 10-year Treasury bond yields fell to 4.386% in trading but regained 4.40% after the release of the Fed minutes, while the Aussie dollar traded steadily in early Asia at just over 654.50 US cents.

While the Fed signaled its intention to keep interest rates in restrictive territory for the foreseeable future, this was not surprising to anyone. The Fed appears in no hurry to lower interest rates anytime soon.

According to the minutes, "Participants continued to judge that it was critical that the stance of monetary policy be kept sufficiently restrictive to return inflation to the Committee's 2 percent objective over time. All participants agreed that the Committee was in a position to proceed carefully, and that policy decisions at every meeting would continue to be based on the totality of incoming information and its implications for the economic outlook, as well as the balance of risks."

Upon close examination of the minutes, gold traders found a glimmer of hope concerning worries about financial stability and the role of hedge funds in the arcane 'basis trade' market.

"Participants noted that in recent months, financial conditions had tightened significantly because of a substantial run-up in longer-term Treasury yields, among other factors," the minutes said. "Participants generally viewed factors such as a fiscal outlook that suggested a greater future supply of Treasury securities than previously thought and increased uncertainty about the economic and policy outlooks as likely contributors to the rise in term premiums. However, they also noted that, whatever the source of the rise in longer-term yields, persistent changes in financial conditions could have implications for the path of monetary policy and that it would, therefore, be important to continue to monitor market developments closely."

The committee observed that over-leveraged hedge funds remain vulnerable to Treasury market volatility, which could necessitate the central bank stepping in to keep yields anchored.

"Several participants emphasised the need for banks to establish readiness to use Federal Reserve liquidity facilities and for the Federal Reserve to ensure its own readiness to provide liquidity during periods of stress," the minutes said.

This warning highlights concerns that the Fed and other regulators have about the central role of hedge funds, with their significant leverage, in the Treasuries market and the 'basis' trade.

In recent months, US regulators, led by the Fed, have been focusing on risks stemming from the 'basis trade,' especially hedge funds utilising their substantial leverage (borrowings) to profit from the price gap between Treasury futures and the underlying cash market.

There are fears that a sudden price move or problems with a hedge fund or a bank could spook the market and force the Fed to inject substantial capital quickly to stabilise the Treasuries market and the US financial system due to the level of leverage involved.

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