Gold and silver took another hit last week following the more-than-expected hawkish tone that came out of the FOMC meeting and Yellen’s press conference that followed. The big surprise was the upward revision in the dot plot that currently indicates three hikes in 2017. The markets have also revised up their outlook about the path of the cash rate next year; for gold and silver this means more downward pressure in the near term – especially if the markets keep revising up their outlook about the cash rate.
The Fed rate hike – fully priced into the markets – wasn’t the main factor behind the recent drop in gold and silver prices; but rather the shift in the tone of the FOMC. This could also be the Fed trying to remain ahead of the markets and keep the possibility of raising the guidance in the future if inflation does start to pick up. Despite the modest gain in inflation expectations, bullion prices took their lead from the rise in yield and gain in USD – the main factors that helped drive down the demand for gold and silver. Also, the “Trump trade” – the rise in demand for industrial and financial companies – has also seem to play a role in reducing the demand for precious metals.
Following the last rate hike by the Fed, the markets still place a low chance of another hike in the first half of 2017: The implied probability for a March hike is only 25%. But in June the odds pick up to 75% and by December the odds of at least a single hike are at 96%; for two hikes the chances are 78% and for three – 46% by the end of 2017.
In terms of weighted average, the chart above shows that the markets estimate the cash rate could reach around 1.2% by the end of next year, which prices in two and half hikes or two to three hikes. This could suggest the markets could raise further their outlook if they were to place more confidence in the Fed’s outlook.
But I think this outlook seems a bit high and the Fed is more likely to raise rates only once or twice next year. After all, even if Trump were to pass legislation to cut taxes and build infrastructure, it will take time before it will be implemented. And then there is also the sharp appreciation of the USD, which is also likely to impede growth in exports and cool down the economy; for imports, it will mean lower prices – another factor that could reduce inflation expectations – again, all playing well for the Fed to slowdown in their rate hike path. And finally, despite the comment made in the last press conference, Chair Yellen isn’t likely to rush into raising rates – let alone raising rates thrice in a year – until it becomes cleaner that inflation is picking up, wages are rising and unemployment doesn’t have much more room to fall.
This week is light on news so the markets will keep digesting what the Fed’s policy move means for the markets. We could see a bit of bounce back for gold and silver after the selloff they experienced last week considering the markets may have a bit overreacted to the Fed’s news. We have started to see a modest fall in long term yields in the past couple of days.
The BOJ will meet this week but isn’t likely to change policy; in the U.S. the main report is the GDP for Q3; the markets expect a modest upward revision to 3.3%. If the report shows a big divergence from this estimate, this could shake up a bit the markets.
In the immediate term we could see some short term gains for bullion prices considering, for now, the markets are revising down their outlook of the Fed cash rate and the USD’s rally is losing some of its momentum. And if the GDP report surprises and fall short of current estimates, this could send another signal to the markets that the rise in USD and yields could come to halt – which, in turn may help boost the demand for precious metals in the near term. But beyond that, gold and silver prices could resume their downward trend as we move towards 2017 if the markets were to expect for more stimulus from the new administration in the U.S. and the Fed maintains its line of tightening.
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