Gold to re-establish uptrend after rate hike becomes fact
THE decision on interest rate hike is on everyone's radar this week. Fed Fund Futures (FFF) is already pricing in a 98 per cent chance of a rate hike on Dec 13 at the Federal Open Market Committee (FOMC) meeting where the Fed Funds Rate (FFR) is set to rise from 1.25 per cent to 1.50 per cent.
Looking back at how far we have come from this rate hike cycle shows an interesting relationship between the FFR and gold.
Contrary to popular belief where interest rate hikes would lead to a lower gold price, the price action around interest rate hike days since December 2015 showed the opposite reaction.
After seven long years of zero interest rate policy (ZIRP) since 2009, the Federal Reserve (Fed) finally commenced the interest rate hike cycle where the FFR nudged from 0.25 per cent to 0.50 per cent. Instead of a further selloff in gold, a bottom was established. Gold bottomed out perfectly one day after the Fed raised the FFR.
Two more similar bottoming price actions played out again in the respective rate hike days in December 2016 and March 2017 FOMC meetings. On both occasions, rates rose 0.25 per cent, shown by the highlighted circles.
The reason for the divergent move in gold even when the Fed raises rates is due to the "pricing in" effect of future rate hikes. Market participants are forward-looking and tend to price in new information that is not yet announced.
Watching the FFF shows the level of conviction the market participants have on the upcoming rate hike. For this current rate hike cycle, prior to the FOMC announcement days, gold tends to move in a sluggish downtrend manner as the market prices in a high probability of a rate hike shown by the red highlighted box.
The selloff in gold usually accelerates when the FFF is above 70 per cent, implying a high probability of a rate hike.
"Sell the rumour, buy the fact" seemed to work well for gold as it bottomed out perfectly one day after the rate hike days.
The only outlier was the most recent rate hike in June 2017, where gold continued to sell off. One explanation for the breakdown was due to the release of new information that the market was not expecting.
In the FOMC statement, new information about the implementation of the balance sheet normalisation programme was announced where the committee expects to reduce the balance sheet by this year.
Since October, the FFF has already signalled a 70 per cent chance of a rate hike in December, which was why gold continued to move in a depressed manner recently, showed by the red highlighted box.
Market participants are pricing in the December rate hike, thus leading to the selloff in gold. If the Fed were to follow suit with the rate hike on Dec 13 and not include any unanticipated language in the FOMC statement and press conference, then we could very well witness a replay of the first three rate hikes since December 2015 where gold bottomed out perfectly one day after the respective rate hike days.
Gold should see a rebound higher to re-establish the uptrend after Dec 13.
Disclaimer: Chartpoint is provided by Phillip Securities Research for information only, and should not be construed as investment advice.
