Yesterday I talked about US interest rates, the US dollar and gold. Let’s continue that discussion today…
Overnight the US dollar strengthened while gold lost ground. That makes sense. The two assets usually (but not always) move in opposite directions. The overnight moves reflect positioning ahead of the US Federal Reserve’s announcement on interest rates, which will happen tonight, our time.
The market already expects that the Fed will raise the official rate to 1.5%. The question is whether it will signal a faster pace of rate rises than the market currently expects.
You could argue the case either way. The US economy is strong. The labour market is tight. However, we are yet to see any real signs of a wage inflation breakout. On top of that, you’ve got Trump’s late cycle fiscal stimulus set to flow through. As I pointed out on Monday, in fiscal 2019 and 2020, the US government will run US$1 trillion deficits.
On this evidence, you could argue that the Fed needs to move a bit faster than it has so far in order to ‘normalise’ interest rates. Monetary policy is still very ‘easy’ and, combined with an outrageous fiscal policy at this time in the cycle, there is a lot of stimulus in the system.
Having said that, the authorities want to generate higher rates of inflation before they raise rates meaningfully. It was only a few weeks ago that the Washington based International Monetary Fund (IMF) suggested authorities leave stimulus in place for longer in order to tighten the labour market further and generate wage rises (and inflation).
Inflation reduces an economies’ real debt burden. Policymakers therefore see a bit of inflation as a good thing, despite it being hugely disadvantageous to those workers who have little bargaining power.
Still, policymakers operate in the aggregate. They have little concern for those impacted at the margin.
Then there is the question of where we are in the cycle, and whether Fed hawkishness is set to hit right as the economy starts to slow.
An article in the Financial Times points out that a measure of credit stress is starting to surface, indicating that financial conditions are getting tighter.
‘The Option Adjusted Spread for the Bloomberg Barclays US Aggregate corporate index has risen above key measures of momentum, or moving averages. The OAS is a measure of the average difference of yields when comparing government and investment-grade bonds. A rising OAS tells us that credit conditions are deteriorating.’
Source: Financial Times
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The article continues:
‘Such a breakdown warrants watching from equity investors and also Fed officials. Record amounts of corporate debt sales in recent years that have helped fuel an aggressive merger and acquisition boom is the kind of late-cycle development that suggests a credit shock looms as the Fed steadily tightens policy.’
With all this in mind, my guess is that the Fed will maintain its current interest rate forecasts, rather than signal a greater than expected tightening. Having said that, it is pretty standard for central banks not to see the end of the cycle looming. They nearly always tighten when the economy is already slowing.
Whatever the short term positioning going on ahead of the Fed’s meeting, it is instructive to step back and look at the big picture. Yesterday I showed you a chart of the US dollar index. Here it is again:
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Even if the dollar rallies post the Fed’s decision, technically, it still has a lot of work to do to be in a strong position. It broke down through long term support in January, which was a bearish development.
Gold often moves opposite direction to the US dollar
Now, let’s compare this chart with that of gold. If you look closely at the two charts, you’ll see that the support and resistance points formed at the same times.
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But while the US dollar index broke down through support in January this year, Gold did not follow. It still had a bit more work to do. In my view, gold’s move higher is just a matter of time. It might not happen tomorrow, next week, or even next month, but when it does, the price is likely to move very quickly.
If you want to profit from this potential move, you need to position yourself now. If you wait, it will be too late.
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Editor, Crisis & Opportunity