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Gold’s Outlook: How Likely Is a Surprise Rate Hike by the Fed?

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Fed getting cues from inflation

While the Federal Reserve kept interest rates unchanged in its policy meeting in January 2018, it raised its outlook for inflation and flagged “further gradual” rate increases.

The Fed cited solid gains in employment, capital investment, and household spending while maintaining its outlook for a strong labor market and moderate growth in the US economy. Following the January meeting, the central bank said, “Inflation on a 12-month basis is expected to move up this year and to stabilize.”

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Getting more aggressive

The most recent US jobs report also underscored the fact that inflation pressures could start building up because wages have grown at their highest rate since mid-2009. The Fed has long maintained that the factors keeping inflation down are “transitory.” Higher inflation expectations will support an aggressive interest rate policy by the Fed. Traders are now widely expecting a quarter-point rate hike in March 2018.

Inflation expectations have suddenly fueled the possibility of a fourth surprise rate hike in 2018 against the three the market and the Fed had expected at the start of the year.

Avoiding volatility

Because inflation figures could enable the Fed to move more aggressively on the rate hike path, consequent rate hike fears have made equity markets tumble. Market participants are of the view that the equity sell-off will be taken into consideration by the Fed in its decision on the future course of rate hikes. They believe that the Fed could avoid adding volatility to the already volatile equity markets by raising interest rates.

Whereas a rate hike could erode gold’s appeal as an investment option, higher inflation should encourage investors to put some money into gold as an inflation hedge. Lower-than-expected rate hikes could benefit gold stocks (GDX) (NUGT) such as New Gold (NGD), Agnico Eagle Mines (AEM), Harmony Gold (HMY), and IAMGOLD (IAG). These stocks fell 14.6%, 3.1%, 6.4%, and 4.5%, respectively, in January 2018.

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