Gold Impact: Can Inflation Rise Enough to Support the Fed Liftoff?
Gold acts as an inflation hedge for investors. When inflation rises, the value of the paper currency falls, as the same currency can now buy fewer goods and services.
In such situations, investors look for an asset that doesn’t lose its value. Gold is one such asset, as it has a direct relationship with inflation. Demand for gold increases as inflation increases and vice versa.
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US inflation measures
The two common measures of inflation used in the United States (TIP) are the CPI (consumer price index), released by the U.S. Bureau of Labor Statistics, and the PCE (personal consumption expenditure) index, issued by the U.S. Bureau of Economic Analysis. The Fed’s inflation targets are based on the PCE index.
The US CPI inflation came in at 1.7% in July, which is lower than the 1.8% median estimate of economists surveyed by Bloomberg. This is the fifth straight month of softer inflation. The core CPI also stood at 1.7% annually in July. Investors should note that the Fed is more concerned about the core inflation.
The Fed has long been saying that the weakness in inflation is transitory and eventually the core inflation should approach its 2.0% target. However, if the current pace of inflation is sustained for a longer period, the Fed might have to rethink another interest rate hike in 2017.
The Fed states its inflation objective in terms of PCE inflation, which should be updated on August 31, 2017. However, generally weaker inflation is negative for the Fed’s case for an interest rate hike.
Higher interest rates are negative for the gold outlook because that environment doesn’t generate any income apart from capital gains.