The Fed hiked its interest rates for the third time during the current tightening cycle. What does it mean for the gold market?
As widely expected, the U.S. central bank delivered the third rate increase in almost a decade. Investors only waited three months for this move as the Fed adopted a more aggressive stance this year. The key paragraph of the released statement is as follows:
“In view of realized and expected labor market conditions and inflation, the Committee decided to raise the target range for the federal funds rate to 3/4 to 1 percent. The stance of monetary policy remains accommodative, thereby supporting some further strengthening in labor market conditions and a sustained return to 2 percent inflation.”
In line with expectations, the FOMC members pointed out the recent strength in the labor market and the rise in inflation, but pointed out that the core inflation remained below 2 percent. Interestingly, the vote was not unanimous, as Neel Kashkari, Minneapolis Fed President, preferred to keep rates unchanged.
As the U.S. central bank increased the federal funds rate, it also lifted its other interest rates by 25 basis points. In particular, as we can read in an implementation note, the Fed raised interest paid on required and excess reserve balances to 1 percent, the overnight reverse repo rate to 0.75 percent and the discount rate to 1.5 percent.
When it comes to the Summary of Economic Projections, the FOMC members generally stuck to their forecasts from December. Importantly, despite a rise in inflation, the U.S. central bankers still see just two more rate hikes in 2017. Therefore, the combined statement and the economic projections were more dovish than expected. This is why the market odds of a Fed hike in June declined. Although investors still see two hikes this year, the expected date of the next move shifted from June to July. Hence, the U.S. dollar plunged against the Japanese yen (see the chart below), while the price of gold surged.
Chart 1: The USD.JPY exchange rate over the last three days.
Indeed, as one can see in the next chart, gold gained about 1.66 percent, rising from $1,200 to $1,220 initially after the release of the statement. As we expected yesterday, there was a classic example of a “sell the rumor, buy the fact” market reaction to the expected rate hike from the Fed.
Chart 2: The price of gold over the last three days.
To sum up, the Fed delivered the third rate hike, as expected. However, it did not revise its economic forecasts upward and smuggled a note that core inflation was little changed and still running below its long-term target. Therefore, the meeting was considered dovish and the price of yellow metal surged. Hence, we see the opposite of what was the case in December when gold prices plunged initially. In December, gold bottomed one day after the December FOMC meeting and started a rally a few days later. Thus, the opposite scenario would imply that we will see a downward move next week.