Path Of Rate Hikes And Gold

We continue on the Fed and the expected interest rate increase in December. We have already said that the gold trade is now about the future path of the hikes. In this article, we analyze how futures markets view rate hikes and what it implies for the gold market.

The CME FedWatch Tool shows at the moment the probability of a December rate hike at 87.2 percent. Investors are almost convinced that the Fed will announce a rise in interest rates at their meeting next week. If the U.S. central bank does not do it, there will be market turmoil. We saw that pattern last week, when the European Central Bank failed to meet the investors’ elevated expectations. In consequence, the euro and gold rose.

But let’s look beyond December. It is unlikely that the Fed will raise interest rates in January, as it would be too close to December and would definitely not reflect a gradual pace of tightening. Moreover, the Fed does not have a press conference scheduled afterwards. Actually, we can exclude January, April, July and November, since these meetings are not followed by a press conference.

The market is currently pricing in a 42 percent probability that the Fed will hike at the March meeting by at least another 25 basis points to bring the Fed's target range up to at least 0.75 percent. This implies that investors predict a 48.2 percent likelihood that the Fed will raise rates again in March provided it raises rates in December (the number is calculated as conditional probability). Therefore, markets expect that the second increase will be no earlier than in June.

What about other meetings? Investors believe that it is more likely that not that we will have seen at least a 0.50 percent rate increase by next June. Future contracts also indicate that traders forecast a 0.85 percent rate by December 2016. Therefore, markets expect a shallower interest rate path than the FOMC members who in September expected that interest rates would reach 1.375 percent in December 2016.

Summing up, as Yellen has said recently, “what matters for the economic outlook are expectations concerning the path of the federal-funds rate over time”. Investors are expecting rate increases amounting to at least 0.50 percent by next June and a 0.85 percent rate by December 2016. Therefore, the shiny metal could remain under downward pressure due to the expectations of another hike or two next year. However, the presented future path of rate hikes should be already incorporated in the price of gold. Therefore, the December meeting could be bullish for gold, provided that the Fed officials’ forecasts would be revised down to reflect their recent emphasis on gradual rate hikes.

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Arkadiusz Sieron

Sunshine Profits‘ Gold News Monitor and Market Overview Editor