FxWirePro: US inflation and Fed repricing trigger shorts in CME bullion futures of far-month tenors

Gold prices were hovering at two-week highs on Tuesday, as a number of geopolitical concerns boosted demand for safe-haven assets, although expectations for an upcoming U.S. rate hike still lent some support to the dollar.

While the US dollar has been crawling ahead in recent days, with the market-implied probability of a December Fed hike inching to around 80%. The FOMC minutes and US CPI data this week will be in focus. Fed Chair Yellen is also scheduled to speak on monetary policy this weekend.

A conceivable bottoming out in inflation in the US and the Fed repricing of a December hike are outright bearish and gold should rebase lower, in our view. To this end, the median Fed participant continues to look for one more hike this year (during Christmas, hiking cycle since 2015 has delivered this festive bonanza) and three more bets in 2018. The 2019 median path was trimmed from three hikes to two, offsetting the somewhat hawkish near-term message.

The lingering market expectations, however, seem quite diverse. Still awaiting a stronger confirmation of a sustained upward trend in inflation, the market is only pricing in less than two full hikes by December 2018, which seems overly pessimistic given the upbeat economic backdrop. This complacency on the Fed is mostly due to the fact that the Fed had signaled its rate decisions would be primarily driven by inflation, which until August surprised to the downside over five consecutive months. The repricing is already taking hold.

Three weeks ago, the rate markets priced no hikes through 2018; today it’s almost two. December hike probabilities have now been mounting from 28% just two weeks ago. The four Fed-related corrections so far this year averaged sell-offs of $28/oz, $58/oz, $76/oz and $84/oz each, with the current sell-off surpassing $50/oz so far. Considering the higher starting point, we believe the downside trade has room to play out further. While further weakness in the broad dollar and re-escalation of political tensions could lend some support to bullion prices, we continue to caution against holding gold as a political hedge during the global rate normalization cycle.

Since September’2017, we encouraged shorts in CME gold for Dec’17 delivery from $1,318/oz levels. Trade target is $1,190/oz with a stop at $1,350/oz.


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