We are going to write about gold in the new non-zero interest rates world in the upcoming edition of the Market Overview in greater detail, but let’s now sketch the possible consequences of the recent interest rate hike for the gold market.
The initial reaction to the interest rate rise was marginally positive for the yellow metal, but the price of gold tumbled yesterday, perhaps due to the rally in the U.S. dollar. It looks that investors changed their minds about the FOMC meeting’s nature (more hawkish than they had believed earlier, as the projections for the federal funds rate were not changed significantly and there was no dissent to the Fed’s decision to raise rates) after digesting the December hike.
What’s next for the gold price? On the one hand, the December hike may be supportive in the long run for bullion, as it may remove rate-related uncertainty from the gold market. On the other hand, nothing will change, as the price of gold will remain very dependent on the Fed’s actions and the investors’ expectations of future hikes.
Therefore, as long as investors do not believe that the Fed has delivered only a one-and-done hike to defend its credibility (we do not agree with Yellen that the data, not the Fed’s credibility issue, lead to the move), the gold market may remain under some downward pressure.
However, we think that the whole expected path of Fed hikes has been already factored into the price of gold. The Fed dot plot suggests four 25-basis point increases next year. Markets expect just two more increases, but we are a bit skeptical about that scenario either, remembering how long it took the Fed to conduct just one baby-step hike. Thus, a more gradual path than forecasted (i.e. expectations of less than two increases in 2016) will be bullish for gold (and vice versa).
The key takeaway is that there is life for gold after the Fed’s hawkish move (this does not rule out declines in the short-term). It is true that the higher real interest rates (but not necessarily higher federal funds rate) are negative for the yellow metal. However, investors should remember that the December hike was not the beginning of the tightening cycle. Real interest rates have been increasing for a few years, partly in response to the Fed’s tapering and shortening of its forward guidance, and the investors’ expectations of the normalization process. Therefore, the shiny metal may catch its breath next year when these expectations stabilize or reverse, especially if the Fed is forced to reverse its position.
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Arkadiusz Sieron
Sunshine Profits‘ Gold News Monitor and Market Overview Editor
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