Fed Readies to Tighten Monetary Policy Post Haste

There is a scarcity of USD on international markets. This is something that does not typically happen, but when it does investors and traders should certainly pay attention. Recent reports by the BIS (Bank for International Settlements) and the IMF (International Monetary Fund) indicate that there is a shortage of USD in BRICS (Brazil, Russia, India, China, South Africa) and other emerging market economies. This is due to the ramifications of Fed policy vis-à-vis the unraveling of monetary stimulus post financial crisis in 2008/2009. The Fed has aggressively embarked upon a policy of monetary tightening since December 2015. This has gained traction of late, and the Federal Funds Rate (FFR) is now standing at around 1.00% – 1.25%.

In practical terms, the shortage of USD in international markets is something that should be taken seriously. The reason for this is simple: The Fed will be tightening monetary policy further, probably in June 2017. According to the CME Group Fedwatch Tool, the likelihood of a Fed rate hike of 25-basis points on Wednesday, June 14, 2017 is now 83.1%. If that rate hike doesn’t kick in, there is a 78.2% probability of a rate hike on Wednesday, 26 July 2017. Simply put, the global economy is staring an additional 25-basis point rate hike in the eye, and this will drive up dollar demand and dry up the supply of greenbacks in the global economy. As more USD are invested in banks and financial institutions, we will see less circulation and slower velocity flow of money through the US economy.

How Will Gold Be Impacted by a Tightening in Money Markets?

The current gold price is $1,230.68 per ounce (May 8, 2017). Over the past 6 months, gold has dropped $53.50 per ounce, or 4.19%. Its 1-year performance is equally glum at $-40.80 per ounce, down 3.22%. The reason we are seeing such negative sentiment in the gold price is the superb performance of US equities, what with the latest US economic data. The Dow Jones Industrial Average is up 18.41% over 1 year, holding over 21,000. The S&P 500 index is up 16.63% over 1 year at 2,399.29, and the NASDAQ composite index is up 28.81% over 1 year at 6,100.76.

These are all staggering levels for Wall Street, and this is precisely why we are seeing weakness in gold prices. Part of the reason for the rally on Wall Street is the release of US economic data. We have seen unemployment drop to 4.4%, and the total number of new jobs added in April up at 211,000. This news has dragged out the bears and chased away the gold bugs, as evidenced by the falling gold price. There are several factors that could weigh heavily on gold, including the situation in North Korea, tensions in Syria, and US/Russia relations. For now though, the calming of tensions in France has thrown gold for a loop, and binary options traders are wasting no time shorting the commodity.

All That Glitters is Not Always Golden

It is clear that the shortage of USD on the markets will be a crucial factor in the cost of the USD. Recall that the Federal Reserve Bank pumped trillions of dollars into the global economy with its monetary stimulus in 2008 – 2012. This dropped borrowing costs to multiyear lows and helped to raise the price of assets. Otherwise known as quantitative easing, or QE, Fed policy was largely effective at preventing a global depression. The Federal Reserve Bank currently has a balance sheet valued at $4.5 trillion, and it is starting to sell off those assets and dry up the money supply. The so-called easy money that the global economy has had access to will soon evaporate, and the money pools that supply USD will be affected. This naturally influences the gold price since the more valuable the USD, and the harder it is to obtain, the lower the demand for gold.

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