Central Bank Weekly: Rebound In Fed Hike Odds Sinks Gold Prices

Brexit, the US-China trade war, concerns over a US recession? Not in the tea leaves, according to Fed Chair Powell; not that the Federal Reserve is moving on policy either way anytime soon, but talks of a rate cut are decidedly overblown. The Federal Reserve is due to stay on hold for the foreseeable future. According to Fed funds futures, there is no greater than a 10% chance of a 25-bps rate hike or cut throughout 2019.

FEDERAL RESERVE RATE HIKE EXPECTATIONS (MARCH 1, 2019) (TABLE 1)

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Central Bank Weekly: Rebound in Fed Hike Odds Sinks Gold Prices

There are movements in interest rate markets beyond the 2019 calendar year that may be contributing to the dramatic shift in risk appetite underpinning the breakdown in safe-haven assets like Gold and the Japanese Yen. We can measure whether or not a rate cut is being priced-in for 2020 by examining the difference in borrowing costs for commercial banks over a one-year time horizon in the future. The spread between the Eurodollar June 2019 and 2020 contracts as well as the Eurodollar December 2019 and 2020 contracts remains below zero – but these spreads have moved sharply back towards positive territory this week.

EURODOLLAR JUNE 2019/2020 SPREAD: DAILY TIMEFRAME (OCTOBER 2018 TO MARCH 2019) (CHART 1)

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Central Bank Weekly: Rebound in Fed Hike Odds Sinks Gold Prices

In fact, the Eurodollar June 2019 and 2020 contract spread is up 9-bps this week to -4-bps overall, up from the -31-bps priced in from the start of 2019. That’s right: since January 1, an entire rate cut has been priced-out by markets. By no means does this indicate that a Fed rate cut is coming anytime soon; but rather, it suggests that the period of ‘patience’ that Fed Chair Powell has been calling for over the past month will be the default speed for the foreseeable future.

GOLD PRICES ARE COLLATERAL DAMAGE TO SHIFTING ODDS

With key thematic influences seemingly breaking all in favor of stronger risk appetite, safe-haven assets have been hit hard. The Japanese Yen has understandably weakened as global equity markets have rallied, and the slight bump in US Treasury yields has filtered through into hitting precious metals as well. With the prospect of a US recession and thus a 2019 rate cut odds seemingly being pushed lower this week, Gold prices have been hit hard. In fact, the performance this week was Gold’s worst performance (-2.62% at the time of writing) since the first week of May 2017 (-3.11%).

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