Yellen Has Lift Off, But Rates Won’t Go To The Moon

At the FOMC meeting last week, the Fed raised interest rates for the first time since 2006. This was a historic moment marks the first rate hike after the Fed engaged in massive quantitative easing programs to combat the Global Financial Crisis and the Great Recession. However, we are not economists or economic historians. We run a trading service and are therefore concerned with where the markets will go next. This means that our key point of analysis is around where rates will go next, rather than what they did last week.

We were short gold going into last week’s FOMC meeting, but reduced our short exposure following the hike and consequent fall in gold. What happens with interest rates over the next year and beyond will determine how gold trades going forward. Therefore our analysis of the future of interest rates will be the most significant component in calculating the risk reward dynamics on potential new gold trades.

Connecting the Dots

The FOMC meeting last week also included the release of the dot plot projections. These show where members believe key economic data series will be going forward, but also, and more importantly, show where members believe interest rates should be. These dot plots are thus vital for speculators in determining the future of interest rates.

The chart above shows how FOMC members believe interest rates over the coming years. The current implication is that rates will rise to 1.40% by the end of 2016, which would take four hikes of 25 basis points each. It is also implied that rates will rise another 100 basis points in 2017. If we believed that these projections would be realised, then we would be limit short gold. However, we instead hold the view that rates will in fact rise more slowly over the coming years.

Oil & ECB

These are two factors that will lead the Fed to tighten at a slower pace than the dot projections currently imply.

Lower oil has led to falling energy prices, but this is not the only reason falling oil prices have caused disinflationary pressures. Energy companies under financial stress have seen credit spreads widen and selling across the board in High Yield debt. This has increased the borrowing costs for the US corporate sector.