Gold has been slipping lower in recent months as we inch closer to a rate rise by the Fed. But will that eventuate? Any delay to a rate rise will send the gold bulls charging.
Gold prices have remained relatively muted in response to the Greek debt crisis which is a surprise. The risk of contagion is quite high and under normal circumstances the price of gold would be propped up by the uncertainty. If we see the new bailout measures rejected by the Greek government then surely they will head for an exit from the Eurozone and gold will benefit.
There are a few reasons that gold has remained low during such uncertainty, and the Fed is the main reason. The market has somewhat priced in a rate rise in September which has seen gold trade lower over the last few months. With all the uncertainty in global markets, can the Fed justify a rate rise? Is the US economy even robust enough?
Back in June when the Fed kept rates on hold, the minutes from the meeting reveal that the members were concerned about global risks but were also seeing signs of a strengthening economy. However, they did say the following: "Many participants emphasized that, in order to determine that the criteria for beginning policy normalization had been met, they would need additional information indicating that economic growth was strengthening, that labour market conditions were continuing to improve, and that inflation was moving back toward the Committee's objective."
Let’s take a look at the data and see if it backs up what the Fed are looking for. The Unemployment rate has dipped from 5.4% to 5.3% which is a positive, but hardly a big improvement. GDP in the first quarter was a dismal (annualised) -0.2% q/q and we will get our first look at Q2 at the end of the month. It will need to be a big number to base an interest rate rise on. Yesterday’s retail sales were poor at -0.3% while Unemployment claims disappointed last week at 297k vs 275k expected.
And then there is China. The meltdown on the stock markets has prompted the government to suspend trading in over 1,000 companies (over 2/3rds the market), whilst making it illegal to sell any shares. Some traders have taken to shorting commodities as a hedge against stocks. This will be problematic and see plenty of short covering if there is a proper market meltdown. The Fed too is concerned with China and the threat a slowing Chinese economy holds.
So is the Fed in a position to raise interest rates? The economy has hardly improved but we are inching closer to a rate rise, and the market may be outpacing that with what it is pricing in. Yellen is due to speak to congress later today and I would not be surprised if we see her remain coy on an interest rate rise. She may sight the risks in Greece and China as well as the US economy not quite being robust enough to handle a rate rise. Any hint that a rate rise in September will not be forthcoming and gold bulls will charge.