Upcoming Rate Hike And Gold

The second Fed hike in a decade is coming. What does it mean for the gold market?

We wrote about this week’s FOMC meeting yesterday, but let’s dig deeper into the topic. It’s definitely worth it, as the Fed hike would be the second upward move in a decade, which may be the key to market trends in the next year. And it is probably the most anticipated rate hike in the history, given the full year of waiting.

Our take is that the Fed will raise interest rates, because the market odds are above 90 percent (today, they are exactly 93.2 percent). With such elevated expectations, the lack of a hawkish move would be a negative surprise for the markets. Moreover, the commercial bank reserve balances with the Fed have diminished since the middle of September. The reduction in excess reserves reinforces the U.S. central bank’s intention to raise interest rates. The fall in reserves was observed before the Fed hike in December 2015. And the state of the U.S. economy does not seem to be an obstacle to raising interest rates.

However, the Fed hike is widely expected. Therefore, what really matters is the U.S. central bank’s guidance for the next year. As a reminder, in September, the Fed expected two rate hikes in 2017, while the market does not expect another rate hike until June. If the FOMC members still see two (or more) hikes, the markets will go up, while gold will take a hit. But if they lower (significantly) their federal funds rate projections, the yellow metal could catch its breath. Last year, the hike was accompanied by a rather dovish message (the FOMC members lowered slightly their projections for the federal funds rate). Surely, this year the Fed will also assure that the path of future rate hikes will be gradual. But with the prospects of Trump’s fiscal stimulus, the Fed may accelerate its tightening cycle and issue a hawkish statement, although we believe that the U.S. central bank will rather wait and see what the actual proposals will be.

To sum up, the strongly anticipated Fed hike is coming. As everyone knows about it, the focus will be on the updated economic projections and Yellen’s press conference to find clues on the future path of interest rates. If the FOMC members project only one rate hike next year, the shiny metal should revive. However, if they send a hawkish message or just maintain their September projections, the price of gold should remain under downward pressure in the medium-term.