Yellen’s Clarifications Spur Global Risk Reversal, Drop the Hammer on Gold Prices
Gold prices slipped to the lowest in over a month following the weekly reopening as financial markets across the globe continued to digest the commentary from the central bankers’ Jackson Hole Symposium held last week. Federal Reserve Chair Janet Yellen headlined Friday’s remarks with her first public observations in over two months.
Echoing many of her colleagues in the Federal Open Market Committee, Yellen took a more hawkish tone in discussing US economic conditions, spurring a selloff in risk-assets like equities and creating a springboard for the US dollar which has recently been under significant pressure, especially after the latest inflation figures. However, now that rate hike speculation is once again on the rise with futures pricing in a massive jump in the probabilities of September action gold prices are back on the defensive as traders reposition for the possibility.
Normalization Efforts Set to Continue
After not speaking in public for months, Yellen’s prepared statement on Friday gave some credence to the idea that the American economy is healthy enough to withstand further potential rate hikes before the end of 2016. The key takeaway from the speech was “in light of continued solid performance of the labor market and our outlook for economic activity and inflation, I believe the case for an increase in the federal-funds rate has strengthened in recent months.”
Although her comments were immediately met with some confusion from market participants believing she hinted at one, and not two hikes before the end of 2016 as indicated by the June dot plots, her trusty deputy swooped in for the save by leaving the door open for September action.
Federal Reserve Vice Chairman Stanley Fischer reiterated the oft mentioned “data dependency” as the key determinant for any future action on rates. In an interview with CNBC on Friday, he touted the upcoming labor report as a major factor in any future decision to raise rates stating, “that will probably weigh in our decision, along with other data that may come in.”
Furthermore, he recapped the possibility of two rate hikes before year end in a sign that the economy may have strengthened to the extent at which a major divergence could start to emerge in global monetary policy. Should the Federal Reserve follow up with not just one, but two rate hikes before year end, it could signal the beginning of an accelerated tightening cycle that will see additional adjustments higher in 2017.
Dollar Boom Signals Gold Doom
Since Yellen’s speech and supporting commentary from other key FOMC members, the US dollar rose by the most since the Brexit vote in June, resonating the possibility that monetary was due for an upcoming shift. The move sent shockwaves through risk and haven assets alike, with major equity benchmarks slipping and precious metals also ending the week lower.
Just as risk assets such as equities tumbled, the rising dollar also saw gold prices slide as well. Although the US dollar index continues to trade in the middle of a range that has remained intact since early 2015 as markets wait for additional confirmation of a further divergence in monetary policy. However, the middle of the range does not play well for gold bugs looking for answers ahead of the upcoming September 20-21 FOMC meeting.
While gold prices are hanging on a knife edge after mounting a spectacular rally over the first half of 2016, no recent new highs are a potential warning sign for the bulls. Although they may cite the broader global growth dynamic which was touched upon during Jackson Hole, namely the need for massive fiscal stimulus from world governments to reset consumer expectations, this misses the bigger picture for gold in a US dollar context.
The epic divergence in monetary policy the Federal Reserve may begin to embark on could fuel massive upside in the US dollar, a potential game changer for any bullish gold outlook. Furthermore, although some are using higher inflation as a reason to hedge in gold, should interest rates keep rising, it will keep a lid on any inflationary upside over the medium-term, further reducing the case for holding gold in a portfolio.
Looking Ahead
The major point of data that the Federal Reserve continues to stress is employment. This week’s release from the Bureau of Labor Statistics on job creation could be the confirmation the market needs to raise its own expectations of a near-term rate hike.
Consensus estimates are currently calling for 180,000 jobs added during August with the unemployment rate forecast to fall modestly from 4.90% to 4.80%. Should the event match or beat expectations, the 33.00% probability of September action could rise even further. However, one event that may derail any action is consumer price inflation figures scheduled for release on September 16th. However, based on the existing commentary of key voting members on the FOMC, the more hawkish sentiment prevailing means the downside risks for gold outweigh the current upside potential, hurting the bullish case that prevailed the first half of the year.
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