The Federal Reserve has concluded its two-day monetary policy meeting. There were no real surprises as the Fed kept benchmark interest rates unchanged. However, the tone of the Fed's statement suggests that a September rate hike is on the cards.
What The Fed Said
At its last meeting, the Fed had raised concerns about Brexit and the weak May jobs report. Heading into the latest meeting, the concerns over Brexit had eased and the June jobs report showed significantly higher than expected job gains.
The Fed said in its statement today that near-term risks to the economic outlook have diminished. It noted that "information received since the Federal Open Market Committee met in June indicates that the labor market strengthened and that economic activity has been expanding at a moderate rate." Further the Fed noted that "on balance, payrolls and other labor market indicators point to some increase in labor utilization in recent months."
While the Fed sees steady growth in household spending, it showed some concerns about business investment, which the central bank noted remains soft. The Fed also closely watches inflation data. Inflation continues to remain below the FOMC's 2% longer-run objective.
Overall the statement suggests that the Fed is more confident about the economy even though inflation remains below its target rate. Heading into the meeting, the odds of a December rate hike were almost 50%, while market was predicting a 20% chance of September rate hike. The Fed has three more meetings this year. Apart from September and December, the central bank will meet in November. However, historically the Fed has never raised rates before a Presidential election. So it is either September or December. Based on the Fed statement and the fact that Brexit has not really had any major impact so far, I believe a September rate hike is on the cards.
Positioning for a September Rate Hike, GLD and GDX Could See A Pullback
It has been a phenomenal year for the SPDR Gold Trust (ETF) (NYSEARCA:GLD) and the Market Vectors Gold Miners (ETF) (NYSEARCA:GDX). Year-to-date, GDX has now gained almost 120%. GLD, meanwhile, is up more than 26%, year-to-date. Both GLD and GDX finished sharply higher on Wednesday even as market participants digested the Fed statement. I believe that the gold bulls are already pricing in a December rate hike. The question is whether bullish case changes in case of a September rate hike.
The reason GLD and GDX strengthened despite indications of a September rate hike is Fed's overall stance, which remains dovish. While the Fed noted that near-term risks to the economic outlook have diminished, it added that the stance of monetary policy monetary remains accommodative. Remember at its last meeting, the Fed had scaled back its rate forecasts for 2017 and 2018.
Further the Fed's statement reflects some concerns about inflation. The Fed said "in light of the current shortfall of inflation from 2 percent, the Committee will carefully monitor actual and expected progress toward its inflation goal." Further, it said that "economic conditions will evolve in a manner that will warrant only gradual increases in the federal funds rate." These statements confirm that rates will be "lower for longer." So in effect a September or a December rate hike should not affect gold's investment case as long as the pace of rate hike remains gradual.
Besides these factors, there is also the Brexit issue. While concerns have eased significantly in recent weeks, uncertainty still remains over the terms of Britain's exit from the European Union (NYSEARCA:EU). Then there is the issue of Italian banks.
Another important factor is the low yield environment, which reduces the opportunity cost of holding gold. As I have said before, yields on $10 trillion worth of sovereign debt is in negative territory. Yields on Treasuries are at record low levels and could go down further as in a negative yield environment, even low yielding Treasuries are attractive.
When you take into account all these factors, there is still a strong investment case for GLD and GDX. We might see a pullback ahead of the Fed meeting in September, especially if the labor market data continues to remains strong. However, in the medium-term, GLD and GDX still remain attractive.
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