Mark this date on your calendar: March 15, 2017. It could be an important day for the markets. As you may know, the Federal Reserve is holding a two-day meeting this coming week and on March 15 at 2 p.m., it will make an announcement on interest rates. Fed Chairwoman Janet Yellen will also hold a press conference to discuss the decision and the state of the economy.
So, the $64,000 question is: Will the Fed hike rates again? If they do, what could that mean for precious metals?
Is A Rate Hike Almost Certain?
A couple of weeks ago, nearly no one expected the Fed to hike interest rates during its upcoming March meeting. Fed funds futures were pricing in a low 20% chance of a rate hike. But, that probability has recently jumped to 82%.1 In other words, most market participants now believe that on March 15, the Fed will hike rates.
This change in market sentiment happened because of recent declarations from several Fed members. Yellen, for example, recently said:
“At our meeting later this month, the committee will evaluate whether employment and inflation are continuing to evolve in line with our expectations, in which case a further adjustment of the federal funds rate would likely be appropriate.” 2
San Francisco Fed president John Williams said that a rate hike is “very much on the table for serious consideration.” 3 And, New York Fed president William Dudley agrees, saying, “the case for monetary policy tightening has become a lot more compelling.” 4
Those are some strong signs that the Fed is getting ready to hike rates. Because of all these statements, it will probably be a huge surprise to the markets if the Fed does nothing.
What does that mean for gold? Conventional wisdom says this probably won’t be good for the yellow metal. As loyal readers of the Daily Pfennig® newsletter know, in a rising rate environment, gold has tended to perform poorly since it does not pay interest or dividends. And, since the U.S. dollar and gold have tended to move in opposite directions, higher rates should push gold lower. Shouldn’t they?
But, could this conventional wisdom be wrong?
Could Higher Rates Actually Help Gold?
Besides the stretch from 1996-2000—when there was a period of a net increase in interest rates and a net decrease in gold price—according to research from Bullionvault, since 1986, gold has more often performed better after rate hikes than after rate cuts. Average monthly returns over a rolling 24-month period have been twice as strong when the Fed is raising rates than when it cuts them.5 That goes totally against the market consensus about how gold should respond to Fed rate changes.
Gold’s behavior during recent periods of rate hikes has tended to confirm that surprising piece of research. For example, the last time the Fed embarked on a tightening cycle was from 2004 to 2006, when rates went from 1% to 5.25%.6 You’d think that such a big jump in interest rates would have crushed gold during that time. But, the reality is that the metal jumped 52% higher during that period.7 The price of gold just kept going up despite the sequence of rate hikes.
The Fed also had a tightening cycle from June 1999 to March 2000,8 when rates went from 4.75% to 6.5%. During that time, gold went up about 7%.9 Or, just look what happened more recently.
When the Fed raised interest rates in December 2015,10 most people thought gold would collapse. But, it didn’t happen. Instead, the yellow metal rallied by as much as 28% in the following months.11 Something similar happened last year, when the Fed hiked rates and gold jumped as high as 11% in the following months.12
What’s going on? How can gold be going up when the Fed is tightening? Well, this is probably an indication that investors are expecting higher inflation in the near future, despite the Fed’s move. So, even if the Fed hikes rate this coming Wednesday, it doesn’t necessarily mean gold will crash.
It’s also important to consider the effects that higher rates will have on the stock market. It’s no secret that the low interest rate environment has been a bonanza for stocks. With rates rising, we might see a correction at some point. That might send investors looking for “safe haven” investments such as gold, and that’s another way higher rates could end up being good for gold.
The bottom line is that there’s no guarantee that higher interest rates will send gold plunging. While past performance is no guarantee of future results, don’t be surprised if the yellow metal keeps marching higher in the coming months – despite another Fed hike. Your faithful Daily Pfennig® team will be closely watching what happens on Wednesday.
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Until the next Daily Pfennig® edition…