Gold: What Fed Rate Hike Of 50 Basis Points Or 75 Basis Points Could Mean

The Federal Reserve’s largest rate hike in 28 years could be coming later today at 2 PM EST. The question is what will happen to the price of gold—an asset labeled as a hedge against inflation but that relationship has broken down lately due to the runaway strength in rivals, the dollar and US Treasury yields.

For decades, the Fed had typically used quarter percentage point rate increases to tame inflation. 

But the larger-than-expected 8.6% annualized sting in the Consumer Price Index for May means the Fed might have to resort to unusually strong medicine to curb price pressures that don’t seem to be slowing from four-decade highs.

Gold’s benchmark futures for August lost about $60 an ounce, or nearly 3.5%, on New York’s COMEX over the last two days on speculation that the central bank could resort to a rate hike unseen in decades. 

The Fed’s 25-basis point (bps) hike in March virtually accomplished nothing. The same could arguably be said of its follow-through 50 bps increase in May. 

Of course, if the Fed keeps adding 50 bps at each of its five remaining rate decisions for this year, it could take rates to as high as 3.5% by the year-end from a virtual zero in February.

But the Fed could do even more than 50 bps a month. That’s what investors are fearing and that’s what caused the S&P 500 to become a bear market—down 22% from its Jan 4. high of 4,819—in recent days. 

As of Tuesday, money market traders had priced in a 96.2% possibility of the Fed settling on a 75 bps hike at its June rate decision due on Wednesday. 

A tiny fraction—3.8%—was leaning toward a 100 bps increase; a proposition that seemed virtually impossible just a week earlier.

So, what will gold do if the central bank sticks to convention and does a 50 bps hike? The Fed has raised rates by half a percentage point a total of 44 times, mostly during the ’70s and early ’80s when it was chasing skyrocketing inflation. Since the early ’80s, such big moves occurred only 12 times.

And what could happen to gold in the event of a 75 bps or larger hike? A 75 bps hike or more has only occurred 28 times since the 1970s. The last time was in November 1994, when the Fed hiked rates multiple times in one year in a move to stave off inflation.

We explore the impact on gold from the two scenarios as presented by Sunil Kumar Dixit, chief technical strategist at skcharting.com.

Scenario A: 50 Basis Point Hike/h2

If the Fed announces a 50 bps hike, gold can throw up a $30 - $50 move as an immediate reaction, taking the metal toward $1,850-$1,880.

Meanwhile, eventual volatility can cause a pullback of $20-$30 from there, for gold to back to $1,790-$1,780.

Scenario B: 75 Basis Point Hike/h2

Gold can drop $30-$75 either in a straight go or in phases. 

We can expect a retest of the $1,800-$1,787 levels initially, followed by $1,755. If the sell-off escalates, even $1,730 will be possible.

Overriding Factors/h2

Gold has been trading well below the 100-Day Simple Moving Average of $1,890 and the 50-Day Exponential Moving Average of $1,865 as well as the 200-Day SMA of $1,843

For a couple of weeks now, we have seen the metal being rejected at the $1,880 high, with prices dropping to $1,805 in Tuesday’s session.

This has created a $74 channel for a potential move in either direction after the Fed's decision. 

If gold manages to breakout above the multi-week resistance of $1,880 and gold bulls show enough buying resolve, prices can reach $1,895-$1,910. Any potential short-term bullish breakout rally has high chances to climax at $1,925-$1,935.

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Disclaimer: Barani Krishnan uses a range of views outside his own to bring diversity to his analysis of any market. For neutrality, he sometimes presents contrarian views and market variables. He does not hold positions in the commodities and securities he writes about.

Written By: Investing.com