While the Fed is likely to restart its rate raising cycle by the year’s end, gold is likely to increase over the coming year as the policy maker remains behind the curve. We maintain our forecast of US$1440/oz for mid-2017, although we may see a price decline in the run-up to a December rate hike. Fed’s policy tightening pressure on gold will be temporary
The FOMC held policy rates steady yesterday, but has begun the process of preparing the market for the next rate hike, which the market has priced-in for December 2016. However, voting members of the committee have significantly reduced their projections for rate hikes in 2017. The average appropriate policy path for 2017 projected by voting members now only sits at 1.1% (implying only two 25bps rate hikes in 2017, assuming we see a 25bps rate move in December 2016). That is down from 1.6% (which would have implied 4 rate moves in 2017). Projections for rates in the longer run have also been revised downward. The Fed also revised downward GDP growth forecasts for 2016 by 0.2%.
As we have argued previously, inflationary pressures in the US are present. Core CPI inflation in the US is 2.3% (core CPE inflation is 1.6%). As weak energy and food prices pass-through the year-on-year calculation, headline inflation is likely to rise from the current subdued 0.8%, closer to the Fed’s target of 2%. The Fed projects unemployment rates to fall to 4.5% in 2018 from 4.8% currently. That sits below the Congressional Budget Office’s estimate of the natural rate of unemployment. In short, the loose monetary policy that will aid the fall in unemployment is likely to be inflationary.
We believe that the Fed’s cautious approach to raising rates is likely to leave the policy maker behind the curve and so increases in nominal interest rates are not likely to keep pace with increases in inflation. As our gold model indicates, such as scenario is likely to be gold price positive.
In the very near term, as the Fed preps the market for a December rate hike, the US Dollar is likely to maintain its strength, which is typically gold price negative. But as we have seen in the past, once a rate move takes place, the Dollar sells off and gold prices tend to rally. Speculative positioning in the gold futures could also decline. However, based on historic relationships between gold and speculative positioning, today’s gold price fails to reflect just how bullish the futures market is. A trimming of speculative positions is likely to just correct positioning rather than price.
The habitual tantrum that markets display after rate hikes also tend to be gold price positive. The market volatility we saw in January 2016 could be taste for what is to come in January 2017. Gold tends to be the port of call in volatile cyclical markets.
Nitesh Shah, Research Analyst at ETF Securities
Nitesh is a Commodities Strategist at ETF Securities. Nitesh has 13 years of experience as an economist and strategist, covering a wide range of markets and asset classes. Prior to joining ETF Securities, Nitesh was an economist covering the European structured finance markets at Moody’s Investors Service and was a member of Moody’s global macroeconomics team. Before that he was an economist at the Pension Protection Fund and an equity strategist at Decision Economics. He started his career at HSBC Investment Bank. Nitesh holds a Bachelor of Science in Economics from the London School of Economics and a Master of Arts in International Economics and Finance from Brandeis University (USA).
