What to Expect from Gold as Fed’s Tightening Cycle Comes to an End – Introduction
Gold is an intriguing metal. All historical manuscripts mention of the important role that gold played in the past. Today, gold’s role has evolved from being a means of exchange to being an investment security. Gold does not have any major industrial use. As a result, most of the gold is bought by central banks and large investment companies. It backs most currencies around the world.
This year, gold has had a difficult period. In August, the price of gold fell to a low of $1120 a ounce. The reason for this was the increased concerns of a strong dollar. As the dollar strengthens, gold tends to weaken as shown in the chart below.
As shown above, the price of gold started a sharp decline when the dollar strength started. Mid last month, as the dollar index weakened, the price of gold started to move up. YTD, gold has fallen by 7% while the dollar index has risen by almost four percent.
Therefore, it is right to say that the price of gold will always be determined by the movement in the dollar. The dollar strength has continued in line with the recent trend in the Federal Reserve. The Fed has recently been in a tightening mood. This year, it has increased rates two times and this month, it will implement another rate hike. Traders will pay a close attention to what the Fed will do in the December meeting. The indications for what will happen will start emerging after the September meeting.
There is a likelihood that the dollar weakness will continue. This is because traders tend to trade on the future. They don’t trade on what the Fed said but what it will do. Therefore, while the Fed will tighten in the September meeting, traders will focus on what it will do in the next meetings. There is a likelihood that the Fed will remain hawkish on a rate hike in December. If it indicates that it will tighten in December, this will be a bullish sign for the dollar.
However, the number of rate hikes in 2019 will be less than the four that will happen this year. This is because more rate hikes will likely lead to the inversion of the yield curve. The yield curve is the gap between longer-dated and shorter-dated treasury yields. The curve has continued to flatten, and more hikes will lead to an inversion. When the yield curve inverts, it will likely lead to a recession. Therefore, it is impossible that the Fed will continue raising rates that could invert the curve.
If the Fed fails to hike in 2019, other central banks will likely start hiking. The ECB has indicated that it will likely start hiking in September next year while the BOJ has indicated that a rate hike is not possible until 2020. The BOE will likely hike in 2019 after hiking in August. Therefore, the dollar will be at a defensive as other currencies start to rise. All this will likely be a good thing for gold.