With the inflation fight so close to being won, it’s unlikely the Fed will want to validate the narrative that rates will have to be cut quickly and consistently next year. For commodities priced in dollars and susceptible to shifts in rate expectations, this may create additional headwinds for gold and crude oil.
By :David Scutt, Market Analyst
- The Federal Reserve will release updated interest rate protections later today. Markets have over for cuts priced in for 2024 with the median economist forecast looking for two
- Given the dramatic loosening in financial conditions since the last Fed meeting, it may use the dot plot and statement to send a far less dovish message
- A strong pushback against market pricing would normally hurt commodities such as gold and crude oil
Crude oil and gold remain pressured despite optimism in other asset classes, easing lower over the past few sessions ahead of the Federal Reserve’s last monetary policy decision of the year.
A firm Fed pushback may see higher yields, USD
A rebuttal from the Fed against rampant rate cut expectations is likely, especially given strength in recent labour market and underlying inflation data, pointing the risk of a stronger US dollar and modestly higher bond yields, especially at the front of the US curve.
For commodities priced in dollars and susceptible to shifts in interest rate expectations and their influence on economic activity, this may create additional headwinds following the event.
A final test of the Fed’s inflation fighting credentials
With the inflation fight so close to being won, it’s unlikely the Fed will want to validate the narrative that rates will have to be cut quickly and consistently next year, creating the risk that economic activity will pick up again, resulting in a reacceleration in inflationary pressures. It’s the exact concern Fed chair Jerome Powell warned markets about during his infamous Jackson Hole speech last year: prematurely easing policy before inflation has truly been tamed.
Markets, economists expect multiple rate cuts in 2024
Right now, financial markets are flirting with the idea the Fed will cut four or five times in 2024, a view not dissimilar to what’s being priced for other central banks that appear far more advanced in the economic cycle, such as the ECB and BoE. The amount of rate cuts priced into those curves seems reasonable given the risks between growth and inflation look far more skewed towards the former. But when it comes to the US, with mortgage rates for a large proportion of borrowers set at rock-bottom levels for decades making the transmission of monetary policy extremely inefficient, pricing looks rich in the absence of a hard economic landing.
While less than US swap markets, the median economic forecast expects the Fed will signal two cuts for 2024 when the updated dot plot is released later today, a view that will effectively add another cut to the Fed’s profile from that issued three months ago where it flagged one more hike this year and two cuts in 2024.
Fed may use dots, statement to counter rapid loosening in financial conditions
Even though the median forecast is not unrealistic, it would not surprise if the Fed forecast only one cut in the latest projections. If it wants to send a message, it can’t merely meet expectations. It will need to exceed them, hence why it may signal it’s comfortably on hold throughout much of next year.
And if it really wanted to send a message, it could scrap the line inserted in the prior statement which noted “tighter financial… for households and businesses are likely to weigh on economic activity, hiring, and inflation”. The acknowledgement it was helping to win the inflation fight effectively handed the task of finishing the job to markets. And guess what markets did with the information? Delivered the largest monthly easing in financial conditions on record, according to the indicator compiled by Bloomberg. Movements in equities, volatility measures, credit spreads, interest rate markets and USD shows the loosening has continued unabated in December.
While the Fed would unlikely be concerned about this near-term, a continued easing in financial conditions would. Can the Fed really say financial conditions are doing the job for them right now? While it’s unlikely, don’t rule out a pre-emptive removal of the phrase in today’s statement. It would send a strong message it wants to take back control of the interest rate outlook.
Gold still scorched from last Monday’s rapid reversal
For a commodity vulnerable to shifts in the US dollar and interest rates, a tough-talking Fed may generate fresh downside risks for gold in the near-term, potentially adding to the unconvincing price action seen since the blow-off-top-like move on Monday last week. Having fallen through $2005 at the start of the week, gold has continued to grind lower, taking out minor support at $1988 in the process.
The inverted hammer candle printed on Tuesday suggests sellers have the ascendency above this level. However, with the 50-day moving average located at $1970 – a level it has respected in the past – any further downside in the near-term may be hard won, especially with 200-day moving average not far away at $1953. Therefore, the risk-reward for shorts at these levels is not particularly compelling even with the directional risks posed by the Fed. You’d like to see how the price interacts initially with these moving averages, should it go on with the current move.
Crude oil still searching for a bottom
While the supply and demand considerations are arguably more complex, the picture for crude oil is far more definitive: the bears are in control.
It’s been a sell-on-rallies play since the time when almost every forecaster was predicting the price would exceed $100 per barrel, with the outbreak of the war between Israel and Hamas and move from OPEC+ to deliver additional non-binding cuts to production in the first quarter next year only providing better levels to sell into.
Even though we’re likely closer to the end than beginning of this corrective episode, until concerns about a hard landing dissipate, pessimism towards the demand outlook for downstream products such as gasoline will likely persist. Demand concerns for other energy products, especially natural gas, is another factor generating headwinds.
Having broken into the $60’s last week on disappointment the latest round of OPEC+ production cuts were not binding on member states, an attempted squeeze higher was thwarted on three separate occasions just shy of $72, resulting in a fat bearish candle printing on Tuesday. Given the ferocity of the rejection, even before the risks for today’s Fed meeting, many traders will be looking for a push towards $67, a level where it found support earlier this year. Below, support is found around $64.35 with more meaningful buying likely to emerge at $62.
On the topside, in the absence of a major positive supply or demand shock, gains are likely to be capped at the 200-day moving average with resistance at $72.80 and $74 in-between.
– Written by David Scutt
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