2011-09-22

Gold turned lower and the U.S. dollar rallied after the Federal Reserve announced plans

Gold turned lower and the U.S. dollar rallied after the Federal Reserve announced plans to extend the average maturity of its holdings of U.S. Treasuries, also known as Operation Twist. The U.S. Dollar Index, a trade-weighted measure of the greenback versus several of the world’s other leading currencies, climbed from negative territory on the day near 76.80 to as high as 77.33. The euro gave up its modest gains against the dollar as it slid 0.2% to 1.3673 this afternoon.

The Federal Reserve announced in its Federal Open Market Committee (FOMC) statement that it will extend the average maturity of its holdings of U.S. Treasuries to provide additional monetary policy accommodation. In doing so, the Fed is essentially repeating “Operation Twist,” the 1960s policy in which the U.S. central bank purchased longer-term Treasuries and sold an equal amount of shorter-term Treasuries in the hopes of driving long-term interest rates lower.

Goldman Sachs chief U.S. economist Jan Hatzius discussed his expectations for the Fed meeting in a note to clients on Tuesday. ”Although not a done deal, we see a high probability that the FOMC will announce further easing steps at the conclusion of this week’s meeting,” Hatzius wrote. He went on to say that some form of Operation Twist “looks very likely,” although the exact structure of it is uncertain.

“We see low odds of a change in the Fed’s communication of its policy objectives…There also appears to be little appetite on the committee for an outright expansion of the Fed’s balance sheet,” Hatzius added. Such an expansion would likely come in the form of a third round of quantitative easing (QE3), which “does not look like a realistic option for the upcoming FOMC meeting.” Hatzius later noted that “the Fed may ultimately decide to move in this direction, but we see little chance that this will happen on Wednesday.”

Although Hatzius did not discuss the implications of the Fed meeting for the gold price, considerable uncertainty remains for the yellow metal, at least in the short term. While Bernanke and his fellow central bankers have committed to a near-zero Fed funds rate through mid-2013, the likelihood of a third round of money printing in the near future remains somewhat low.

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