dollar rally

Gold Falls On Stronger Dollar After Rate Hike

December 17th, 2015 by

Although the precious metals rallied leading up to yesterday’s decision by the Fed to raise rates, Thursday saw the opposite occur. Gold and the other precious metals gave up most (if not all) of their gains from the previous day. Meanwhile, the global stock markets surged on greater risk appetite now that the outlook for the Federal Reserve appears more settled.

Much of the metals’ losses, and virtually all of gold’s, was attributable to gains for the dollar.

Higher Rates, Stronger Dollar

rising dollar chartThe DXY dollar spot index was better than 1% higher on Thursday morning to just under 99.0. This largely contributed to the gold price being dragged more than 1% into the red, $12 lower to $1,060/oz. Silver and platinum actually fell even further. The two metals lost 3% and 2.5%, respectively, shortly after markets opened on Thursday. This erased all of the previous afternoon’s gains and then some.

Although the Fed only raised rates by a quarter of a percent (25 basis points), the signal that rates are set to gradually climb naturally dampens the outlook for the gold price. Not only do higher rates mean a commensurate rise in the opportunity cost of holding or storing gold, it also supports a stronger dollar. The resulting rise in the USD due to higher interest rates could also be exacerbated if other central banks around the world continue to go the other direction by easing monetary policy.

fed_funds_Bloomberg

Source: Bloomberg

Germany’s Commerzbank, however, believes that the precious metals will still rise through 2016 in spite of progressively higher rates from the Fed. They point out two reasons to support this view, one of which is forward-looking and the other relies upon history. First, with the Fed finally offering a somewhat clearer path about the gradual nature of its rate hike plan, in some sense the concern of hiking rates in a downturn has been removed. It’s also clear that the Fed isn’t going to act rapidly, either. This eliminates some of the downward pressure on the metals. Second, recent history points to considerable strength during the previous “hiking cycle.”

In the green-colored area of the chart above, the Federal Reserve evenly increased the fed funds rate over a 2-year period. In the first year of this cycle, despite consistent and successive rate hikes, the gold price was able to advance 11%. It’s fair to reason that, with more shallow rate hikes and less of them expected in 2016, spot gold could perform similarly this time around.

Mitigating Risk

While the Fed has done much to project a more steady image of itself with its first rate hike and attendant forward guidance, the futures markets and some economists are not so convinced the central bank won’t be forced to backtrack on its plans if the economy weakens. Reflecting this concern are the adjusted probabilities of the Fed raising rates during 2016. Based on a survey of various traders, the chances for the FOMC to increase rates at back-to-back meetings by moving again in January is in the single digit percents. However, the odds of a rate cut in January (the first time such a move is a real possibility, since rates have been stuck at zero) are slightly better, around 16%. For subsequent FOMC meetings in 2016, the given chances of rate hikes become more likely.

Philippine-stock-market-boardThe U.S. financial markets responded well to weekly jobless claims falling by 11,000 to 271,000 new claims last week. This was below consensus expectations, a sign the labor market continues to marginally improve. On the other end of the spectrum, however, the Philly Fed business survey revealed more bad news for the manufacturing sector.

This kind of mixed news is likely to continue as the American economy seems on a path to diverge from the global markets. Such concerns do provide some support for gold, which is what causes bouts of short-covering in the gold trade. HSBC sees only a limited upside for such short-covering to substantially help the gold price rise over the near-term, though.

 

The opinions and forecasts herein are provided solely for informational purposes, and should not be used or construed as an offer, solicitation, or recommendation to buy or sell any product.

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