Buying Gold into a Fed Hike: As Dumb as it Sounds?
The US dollar is strengthening; fiscal policy is about to ignite economic growth; the ECB has reduced its rate of QE purchases; the Fed will hike interest rates this week. It’s remarkably similar to this time last year, before gold rallied almost 30%. What matters most is what will happen relative to expectations. The market has some lofty expectations built in at present, which is why it could be a case of buying the rumour and selling the fact over coming months.
The hike has been so well signaled, and so well priced into financial markets, that when it is confirmed it will have little effect. Those arguing against being long gold are perhaps not considering the extent to which this hike is expected. What matters more is the tone surrounding the hike and the projection of future rate expectations.
Gold prices exhibit an inverse relationship with the US dollar, particularly against the Japanese yen. In order for the dollar rally to continue, it will take a hawkish Fed that signals further tightening over and above the markets’ current expectations. If the dot plot is unchanged, the dollar could weaken and take gold prices higher.
The relationship between gold and USD:JPY has become more apparent due to the widening interest rate differential between the two. Japan has pledged to keep its 10-year bond yield near 0%, but US bond yields have risen significantly as the market bets on aggressive tightening from the Fed in response to inflationary fiscal policy next year.
The market has grown more confident of a sustained uptick in economic data, driven by policies from the new administration. However, the market is placing little chance of anything derailing the programs and their effects. Trump cannot simply flip a switch when he takes office.
Last year the December FOMC marked the low point for gold. It was a classic case of how buying the rumour and selling the fact was the best trading strategy. This will be the case again. Every time the Fed hikes, the hurdle for the next hike is higher. The level of economic strength required for the first hike is minimal compared to what the Fed will need to see for the third and fourth hikes.