Last month, the Federal Reserve confirmed what many expected with regard to increasing the base interest rate. The US Federal bank rate was doubled from the previous 0.25% to 0.50% in an event that triggered similar increments amongst major banks.
Bank of America (NYSE:N:BAC), Wells Fargo (NYSE:N:WFC) and Goldman Sachs (N:GS) among others, all upped their lending interest rates though none revealed whether they had done the same for deposit rates. This implies that the cost of borrowing increased instantly and thus those with credit facilities that have floating interest rates should expect a change in their statements in the near future.
US equities also rallied with the three leading indexes the S&P 500 Index, the NASDAQ Composite, and the Dow Jones Industrial Average all closing the day in the green. The DJIA was up 1.28%, S&P 500 edged 1.45% while the NASDAQ Composite increased by 1.52% from Monday’s closing figures.
Image 1: U.S. Major Indices advanced on rate hike decision
However, the biggest surprise came from the way gold investors reacted to the news. In the early hours of the day, the yellow metal spot price hovered around the $1,065 mark, but as we moved closer to the announcement, gold price sparked to about $1,073-$1,076 and even after confirmation of the rate hike the yellow metal still remained steady trading well above $1,070 mark.
This is not the first time the yellow metal has surprised traders. Early in December when Yellen gave a strong indication that a rate hike was coming in the same month, many thought that the price of the yellow metal would plunge as expectations on interest rate hike moved from a likelihood status to a more certain sentiment in the market. The price of the yellow metal retaliated by advancing significantly following the news and it showed after the rate hike again that perhaps there is more to what moves gold price than a simple interest rate hike, which had been more or less priced in from months ago.
Image 2: Gold price reaction after the rate hike.
Following the announcement, it is quite clear that the price of the yellow metal did experience some turbulence in the first few hours post the announcement at some point dropping below the $1,070 mark. But a majority of the time the price of the yellow metal remained above this threshold.
This move set the stage for the following few weeks’ trading activity with cautious traders and investors seeking to pounce after the dust had settled. The price of gold has maintained higher trading levels since then and is now up $30 to trade at about $1,100 the highest level reached since early November, last year.
Investing in gold is no longer a preserve of corporate institutions and central banks, these days, individuals are playing a part as well and these are most likely among the group of investors that chose to stay on the sidelines during the volatile trading period.
Emerging technologies and platforms such as Bitgold, which is a digital payments platform that allows traders to buy and sell gold bullion online, are making it easier for individuals to participate in the gold bullion market.
This means that rather than just trading the yellow metal as a commodity or currency on various trading platforms, they can now buy and hold gold for longer periods in the form of cash or real gold. This could be particularly important given the unpredictability of the price of gold in the short term, in recent times. The S&P/TSX Composite traded Bitgold has managed to register more than 500,000 users on its platform, since launching last year.
As such, with the price of the yellow metal increasingly looking unpredictable after the interest rate hike, this may yet serve as an incentive for investors to acquire gold with a long term view rather than speculate on short-term volatility.
Why gold bears should trade the interest rate hike with caution
Now, earlier I pointed that the issue of the rate hike having been already priced in prior to the announcement. That is one of the possibilities, but even the more worrying issue for those anticipating a bearish gold price as we begin 2016 is the fact that it is not clear when the next rate hike is coming.
This is because Janet Yellen, the Fed Chair, and the committee appear to be highly betting on US inflation rates to improve in which case it would justify the decision to increase interest rates further.
Image 3: U.S. Projected inflation through Year 2020.
When Yellen was delivering her statement, this chart popped up in the presentation as an illustration to the Federal committee’s expectations on inflation rates through 2018.
In the statement, Yellen said that the current inflation rate does not reflect what the committee expected, but maintained that the 2% target remains realistic for now as per the projection. However, from an analytical perspective, even looking at the chart above it is pretty clear that the expected rate at the end of 2015 versus what is expected at the end of 2016 will require a big move to get there.
When Yellen was addressing questions from journalists, nearly three-quarters of the time spent on inflation and yet at the end of it all people were still left with questions regarding the issue. From a positive perspective, Jobs numbers have been good and still continue to be good while the unemployment rate continues to decline.
Some key indicative numbers in manufacturing and consumer spending have also been good pointing to a continuous improvement in the US economy. However, one stumbling block and this could be the key in the whole structure is the fact that wages are still below expectations and these together with inflation, have a symbiotic relationship.
In addition, the rest of the global economy especially in the developed countries and emerging markets continues to underwhelm and these could also end up affecting the US economic status. The good thing though is that the Federal committee will be monitoring developments in key economic indicators including global numbers upon which it would be ready to tweak its monetary policy should indications suggest a possible impact on the current projections.
Nonetheless, this could also presuppose a situation where, gold, which has for years been used as a safe haven during economic crises/uncertainties, begin to see increased bullish sentiment as investors move to hedge their investments in income assets. Perhaps, this bullish sentiment has already started given the current price levels.
Conclusion
The bottom line is that Yellen noted that the previous interest rate of 0.25% was a small number (I agree with this statement), and also added that the current increment is a small move (I do not agree-it’s a 100% increment). Therefore, the question is, given the current economic status and the situation a year ago, what has a changed to warrant such an increase?
One of her notable points stated that the increment was done in anticipation of an increase in inflation which suggested that the move was taken to possibly avoid inflation overshooting the current economic policy. This is somewhat contradicting the current situation though as inflation remains significantly low compared to what the committee had expected.
The base scenario is that inflation increases as per the projections, or at least, it comes close in which case another rate increase could come soon (as per the gradual increment statement). However, the worst case scenario and this would make gold bulls smile is that inflation remains tepid for the foreseeable future prompting the committee to tighten its monetary policy thereby raising question over the initial rate hike.
This could create more demand for gold, or has gold already turned the corner at $1,100?