Gold embarked on an aggressive recovery in the first quarter of 2016, buoyed by a slump in Federal Reserve rate hike expectations. A dovish shift in investors’ policy bets reduces the opportunity cost to owning gold versus interest-bearing assets while boosting demand for alternative stores of value to hedge against increased inflation risk. Prices traded to just shy of the $1300/oz figure, hitting the highest levels in over a year.
When the Fed projected 100bps in 2016 tightening following post-QE rates “liftoff” in December, traders priced in just 50bps. As the calendar turned to 2016, the prospect of a more hawkish central bank than had been accounted for in asset prices triggered risk aversion. Dropping stocks – a proxy for broader sentiment trends – echoed into priced-in Fed views as investors questioned whether policymakers will make good on stimulus withdrawal amid market turmoil. After briefly dropping rate increases from the outlook entirely in February, traders settled on one 25bps increase before year-end.
Fed Chair Janet Yellen and company responded by slashing the projected rate hike path to imply two 25bps hikes this year. Subsequent comments from central bank officials offered a relatively upbeat tone on domestic prospects and cited external forces including the slowdown in China as the rationale for opting for a more cautious stance. Taken together, these moves may imply a new strategy aimed at realigning official and market-based rate hike bets, presumably aimed at setting the stage for a smoother hike in June.
Indeed, the case for tightening remains compelling. The unemployment rate has dropped to 4.9 percent, the lowest in eight years. Meanwhile, the Fed’s favored core PCE inflation gauge showed price growth accelerated to a three-year high of 1.7 percent year-on-year in January. Critically, this happened before headwinds to price growth eased as the US Dollar weakened and crude oil prices rebounded in February, meaning the Fed’s 2 percent target is probably even closer to being reached.
