The possibility of a Fed rate hike is around 60% by the by the end of the year. And the shift in the chances of a hike, which tend to move a daily basis, should have also impacted the direction of gold price. The basic idea is when the chances of a hike rise, long term interest rates tend to rise; and since LT yields tend to be negatively correlated, the price of gold will tend to move downward. So far this year, the chances of a hike have mostly come down as the Fed reduces its aim from raising rates several times to maybe squeeze a single hike in the December meeting.
But does this three-way relationship hold true? I.e. does the chances of a rate hike move gold prices via LT yields? Do they move gold at all in any other direction?
To answer this question, let’s look at a simple regression analysis (weekly scale) of the price of gold as a dependent variable and the explanatory variables are: 10 year U.S. treasury yield (yield10), trade weighted ave. U.S. dollar (dollar) and chances of a rate hike by December 2016 (rated). All series are in log to represent percent changes. The results of the regression analysis are represented here below:
Source: My calculations and Fred
As you can see, both dollar and yield10 have significant coefficients, which show robust and negative correlations, as expected — higher yields or strong dollar leads to a fall in gold price. But the more interesting result here is regarding the rated coefficient; it isn’t significant. This means the weekly chances in the chances of a rate hike aren’t an important factor by itself in moving gold especially after controlling for the chances in LT yields.
This result may not seem earth shattering but keep in mind that the chances of a rate hike should move inline with LT yields but in fact since there are other factors moving LT yields — e.g. inflation expectations and uncertainty in the markets — we could see the chances of a hike picking up even though yields come down or vice versa.
Bottom line: The shift in the chances of a hike are another important figure to look for but it only has a partial impact on LT yields and they are the more important series to look for when considering where gold prices are heading.
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