Theshowed that June is a live meeting. Now the question is: will the Fed raise interest rates in June?
The U.S. central bank managed to convince the markets that a June rate hike is on the table, pushing gold down. We do not preclude such a move, however, we would like to draw the investors’ attention to a few arguments why the Fed could be reluctant to raise interest rates next month.
First, the recent data, especially about manufacturing, does not suggest a rate hike.
Second, the British referendum on the United Kingdom’s membership in the European Union is scheduled just one week after the FOMC meeting. It is uncertain whether the Fed will risk an interest rate hike before such an important event.
Third, there are presidential elections in November. Some analysts argue that the Fed is not likely to risk market turmoil caused by a rate hike before the elections, since it could affect the outcome of the elections.
Fourth, the FOMC members often talk a lot, but do a little. Indeed, they have been talking about the normalization process and interest rates hiking for years, but they managed to raise interest rates just once. This is because they prefer to influence the markets by forward guidance, not real actions, since such a strategy gives them more elasticity, and they do not believe that the costs of waiting are really significant.
Fifth, there is the Fed’s catch 22. The catch is that the Fed’s communications influence markets’ expectations, which in turn affect the monetary conditions, shaping the U.S. central bank’s ability to conduct a monetary policy. For example, in the, the FOMC members explicitly noticed such a mechanism:
“Financial market conditions improved further, on balance, over the intermeeting period, with investors appearing to respond to Federal Reserve communications that were viewed as more accommodative than anticipated (…) Over the intermeeting period, broad U.S. equity price indexes moved up, on net, likely because of investors’ views that monetary policy would be more accommodative than previously expected along with an improvement in risk sentiment (…) In the view of many FOMC participants, Federal Reserve communications after the March FOMC meeting led financial market participants to shift down their expectations concerning the likely path of the Committee’s target for the federal funds rate.”
As one can see, the Fed admitted that the U.S. financial markets are sensitive to the Fed’s forward guidance. This is how the catch works. The Fed claims to be data dependent, so it can hike interest rates only when data warrants it. But as the Fed sounds more hawkish, investors respond by shifting up their expectations of the future level of interest rates. In consequence, the market interest rates rise, assets are sold off, and monetary conditions tighten, preventing the Fed from hiking.
The bottom line is that the U.S. central bank convinced the investors that a rate hike is on the table for June. In consequence, the price of gold declined. Although the Fed can tighten during its monetary policy next month, this is still far from a certain outcome. They are a few arguments why the Fed could postpone a decision to raise interest rates again. Such a scenario would be positive for the gold market.