The latest FOMC statement was almost the same as the previous one. And it came as expected. But was it really a non-event for the gold market? Not necessarily. You just have to dig into the statement. Or read our article, as we have read the statement carefully.
Yesterday the FOMC published the monetary policy statement from its latest meeting that took place July 31-August 1. There are no fireworks in the statement. In line with expectations, the FOMC kept the target range for the federal funds rate at 1.75 to 2 percent. And the statement was little changed from the June version. The most important modification is the more upbeat description of economic activity – instead of “solid” we have “strong” growth rate now. So the key paragraph of the recent monetary policy statement is as follows:
Information received since the Federal Open Market Committee met in June indicates that the labor market has continued to strengthen and that economic activity has been rising at a strong rate. Job gains have been strong, on average, in recent months, and the unemployment rate has stayed low. Household spending and business fixed investment have grown strongly. On a 12-month basis, both overall inflation and inflation for items other than food and energy remain near 2 percent. Indicators of longer-term inflation expectations are little changed, on balance.
Sounds optimistic, doesn’t it? Hence, brace yourselves for the next interest rate hike as soon as in September. The substitution of ‘solid’ for ‘strong’ may look inconspicuous. But let’s note that the Fed used the world ‘strong’ (or its derivations) four times in the first paragraph. For us, it means that Powell and Company clearly wanted to signal that they intend to lift the federal funds rate two more times this year.
Is the Economy Ready for Further Tightening?
Yes. U.S. GDP grew 4.1 percent in the second quarter of 2018. And it might increase 5.0 percent (up from 4.7 percent forecasted previously) in the third quarter, at least according to the Atlanta Fed’s GDPNow Forecast Model. The unemployment remained low, while inflation reached the 2-percent target. Personal income increased 0.4 percent in June, while real personal outlays rose 0.3 percent. The ADP employment increased 219,000 in July, more than expected. The risks are roughly balanced. So, yes, the economy should withstand another hike. But will gold survive it? After yesterday’s meeting, the price of gold declined, as one can see in the chart below.
Chart 1: Gold prices (London P.M. Fix) from July 30 to August 1, 2018.
Implications for Gold
What does the Fed’s recent monetary policy statement mean for the gold market? Well, the Fed paused its tightening cycle, so it’s definitely a better scenario than an unexpected hike. Although the wording of the statement was virtually identical to the prior one, the U.S. central bank characterized the economy as strong, signaling effectively the next two hikes this year, which may exert some downward pressure on gold prices. The markets are pricing in roughly a 90-percent probability of another upward move in September and about 70-percent odds of another hike in December.
However, we shouldn’t forget that investors are forward-looking. They are looking beyond 2018. The Fed’s dot plot suggests three hikes in 2019. But markets are pricing in only one upward move in interest rates next year. It creates a hazard for gold prices. The markets are now behind the U.S. central bank. It means that the investors’ expectations will have to adjust one day, as we don’t expect that the Fed is likely to change its course. If it continues its policy of gradual tightening, which is very likely, the markets will have to catch up. When they turn more hawkish, the yellow metal may be under downward pressure.
Disclaimer: Please note that the aim of the above analysis is to discuss the likely long-term impact of the featured phenomenon on the price of gold and this analysis does not indicate (nor does it aim to do so) whether gold is likely to move higher or lower in the short- or medium term. In order to determine the latter, many additional factors need to be considered (i.e. sentiment, chart patterns, cycles, indicators, ratios, self-similar patterns and more) and we are taking them into account (and discussing the short- and medium-term outlook) in our trading alerts.