At the Fed meeting this week, a rate increase of 75 basis points is essentially guaranteed. After then, the future is more challenging to forecast. Traders anticipate the Fed will suspend its rate-hike cycle after this year due to the economy’s fast cooling. We think market participants have underestimated how much tightening will be required to control inflation, which is the Fed’s current top goal.
We anticipate that the fed funds rate will go in a higher and steeper direction than what the market is now pricing. In contrast to market predictions of 3.25 per cent to 3.5 per cent, we think the fed funds rate will reach 3.75 per cent to 4.0 per cent by the end of the year.
Most traders believe that the Fed will maintain such rates until mid-2023. Up from 4 per cent in our prior prediction, we anticipate the central bank to keep raising rates until the high end of the target-rate range hits 5 per cent in mid-2023.
Our revised call was modified primarily due to a hawkish adjustment in the Fed’s response function. Chair Jerome Powell has stated that the central bank is focusing on headline inflation indicators rather than the unemployment rate linked with price stability since it is likely temporarily excessive.
The Fed’s response mechanism appears to have altered recently. Powell recently said that the natural unemployment rate is probably temporarily higher than the standard 4 per cent because of difficulties in finding a job. According to a former senior member of the Fed, it is 5.25 per cent. A current employee places the figure at 6%. The statistics on job vacancies and resignations are compatible with an unemployment rate of zero, indicating that the natural unemployment rate would be considerably greater than those projections.
Powell has also stated that the Fed is now considering headline inflation in addition to the core PCE deflator. Other FOMC officials have recently said that CPI influences interest rates.
These developments have impacted the expectation for the fed funds rate to a certain extent.
Many investors predict the terminal fed funds rate to be between 3.6 per cent and 3.7 per cent using the conventional assumptions of a natural unemployment rate of 4 per cent and a Fed targeting core PCE. That is comparable to the current pricing for euro-dollar futures.
Market players also expect that the terminal rate will be significantly higher, at 5% in mid-2023, if those two assumptions—using headline PCE inflation rather than core inflation and setting the natural unemployment rate at 5%—are changed.
Early on Wednesday in Asian trading, oil prices increased as industry data revealed a larger-than-anticipated reduction in U.S. crude stocks.
According to API data, gasoline stocks decreased by 1.1 million barrels compared to forecasts for an increase of 3.5 million barrels. Later on Wednesday, the Energy Information Administration of the U.S. government releases its weekly oil report.
After Russian company Gazprom announced it would reduce flows via the Nord Stream 1 pipeline to Germany to a fifth capacity, prices soared further as traders expected a tighter gas supply in Europe.
The dollar dropped slightly on Wednesday as investors awaited the U.S. Federal Reserve’s crucial interest rate decision, which may affect the outlook for bullion. Traders are also worried about the economic weakness in the U.S. while the Fed is holding a hawkish monetary policy stance.
As mentioned before, the Fed is expected to increase the interest rate by 75 basis points in their meeting today. This increase in the interest rate is already very much priced in the market, and if the Fed delivers on this, we expect the gold prices to move slightly higher while the dollar index moves lower.
What matters the most for the gold prices is the future path of the Fed interest rate, and this is where traders are likely to see the most significant reaction in the market.
If the Fed shows that they will increase the rates by 75 basis points in the coming meeting, that would be highly bullish for the dollar. As a result, we could see a steep sell-off in the gold price.
On the other hand, if the Fed says that the future interest rate increase could be somewhere near 50 basis points, the gold price may continue to rally.