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Gold Declines On Rising Interest Rate Expectations

July 21, 2016, 9:07 AM Arkadiusz Sieroń , PhD

Yesterday, the price of gold hit a three-week low. What does it imply for the gold market?

Gold prices ended yesterday’s U.S. session at $1317.70, losing about $14 from the previous close. Why? The identification of the causes of the ups and downs in the markets is never an easy task (investors and analysts love narratives which can sometimes help to make sense of pure facts and numbers, but often do not have much in common with the truth), but it seems that the main reasons behind the fall were: a rallying U.S. dollar, better risk appetites and rising interest rate expectations.

As we wrote yesterday, “there is a lot of room for an upward recalibration of market expectations of the Fed rate hike this year. Such a correction would put important downward pressure on gold”. Indeed, some Fed watchers have recently noted that the U.S. central bank could potentially raise interest rates as early as September. In consequence, although expectations for a rate hike in July are practically nonexistent (1.2 percent chance of raise), markets are now pricing in a 24.6 percent chance of a move in September, up from 18.8 percent yesterday. Markets are also pricing in a 25.7 percent chance of a rate hike in November, up from 20.1 percent on Tuesday. And there is a 41.6 percent chance the Fed will raise interest rates by its December meeting, compared with less than 20 percent a few weeks ago. Rising rate hike expectations supported the U.S. Dollar Index which reached a four-month peak, exerting downward pressure on gold.

We remain skeptical about the condition of the global and the U.S. economy and the Fed’s willingness and ability to hike, however, it is possible that the market is a bit too complacent about the Fed. As the Brexit vote did not cause a financial crash, there may be a more upbeat FOMC statement next week and endless Fed officials’ speeches about diminished global risks. Another short-term risk for gold is that investors could unwind their safe-haven bids as the initial shock from the Brexit vote dissipated.

Summing up, the probability of a Fed rate raise increased yesterday. The return of expectations of a rate hike boosted the U.S. dollar and exerted downward pressure on gold. Additionally, there is a retreat of some of those safe-haven bids that have supported the yellow metal. Thus, the coming week may be tough for gold, as we could see more upward recalibration of market expectations of the Fed rate hike this year. However, there are still headwinds to global growth and the fundamental case for gold seems to be bullish in the long-term. Another factor that may influence the price of gold in the following days is today’s ECB meeting. Stay tuned!

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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.

Thank you.

Arkadiusz Sieron
Sunshine Profits‘ Gold News Monitor and Market Overview Editor

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