Gold and silver prices fell again last week, as the U.S. dollar depreciated against leading currencies. Will gold and silver change course this week? We could dance around the obvious and talk about the other reports and events that are on this week’s docket, but the main course will still be the FOMC’s meeting that is likely to crowd out other items and have the strongest impact on precious metals. So let’s get right to it and examine how this event could move gold and silver:
This month’s meeting isn’t only about whether the FOMC raises rates or not, but also what will be the message of the FOMC in each scenario. As I see it we have five possible outcomes in the order of their likelihood:
- No rate hike, but a hawkish statement: This is the most likely possibility at this stage: If the FOMC doesn’t raise rates, it’s still likely that the wording of the statement will be a bit more hawkish than in the previous statements. Then, FOMC Chair Yellen is likely to keep the market guessing about the timing, quoting her tired old mantra “the decision will be data dependent”. In this case, gold and silver may see a modest gain in prices as it will delay the rate hike to another period;
- No rate hike, and a well-balanced statement: It’s also very likely that the FOMC will be on the fence and perhaps presented, given the recent developments in the markets (e.g. China, falling stock market, and weak commodities markets), a more balanced statement that will cite both the pros and cons for raising rates at this stage. There isn’t a big difference between the two outcomes, but in this scenario gold and silver are likely to remain virtually unchanged;
- Rate hike of 0.25% with a lot of “sweeteners”: The Fed could still raise rates this month, albeit the chances seem, for now, very slim. Therefore, this could be surprise for the market and prompt a very strong reaction with the U.S. dollar rising and bullion prices falling. Even though the Fed raises rates in this possibility, the statement and press conference are likely to be very dovish and try to calm the markets by saying the next rate hike won’t occur any time soon, etc.
Obviously, there are other possibilities that have a positive probability such as raising rates by a higher rate than 0.25% or taking a more dovish tone. But I think these three possibilities are the most likely to occur. Currently, the implied probabilities for this week’s rate hike are very low at 23%, while in October and December the odds are higher at 39% and 58%, respectively.
Source: Bloomberg, FOMC
As you can see above, the reaction of gold and silver to the last meeting wasn’t harsh. Also, the reaction tended to zigzag from meeting to meeting as the FOMC left the market guessing about the timing of the rate hike.
The FOMC meeting isn’t only about the statement and the press conference; it’s also about the dot plot and economic outlook. The market will examine these figures as well and try to determine the FOMC members’ outlook for the cash rate in the near term and the economic conditions.
Even if the FOMC doesn’t raises rates this month but in December (or January or a later date), the FOMC is still on course towards normalization. And in this case, it will be much harder to consider another “inflation fear” as we had back in 2011-2012 when the Fed had low rates and implemented QE programs.
Source: FRED
Also consider that the rise in core PCE back in those years also instigated a spike in gold prices, as you can see in the above chart. Back in 2001-2007 inflation picked up – to even higher levels then in 2012 – and still gold prices only slowly climbed. It’s all about expectations you might say. But even expectations weren’t off the charts to warren such a reaction. It’s more related to the drop in long term yields and fear of some investors over potential spike in inflation down the line. In any case, these inflation fears are less likely to resurface any time soon as the Fed moves away from near zero rates.
Bottom line
I still think the Fed isn’t ready to push the hike button at this point. So we could actually see a short term bounce in gold and silver prices following the release of the FOMC meeting.
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