The Fed Rate Cut Sends Shivers Through the Market
In a move that caught many off guard, on Tuesday 3 March the Federal Reserve announced that it was cutting 50 basis points. While the market fully anticipated that they would cut rates at the meeting on 18 March, many were surprised that the Fed believed this announcement could not wait for another 15 days, signalling just how dire they believe the current situation to be. Gold bounced by 3.1 percent, rebounding above the USD 1,600/oz territory, while equities continued to falter. Our last article warned of a potential retreat in the gold price which actually materialised as the gold price shed 3.6 percent. So what is the outlook on the gold price?
The central bank slashed rates by half a percentage point, its biggest single cut in more than a decade. In modern history, the Federal Reserves have only cut rates out of expected schedules following two incidents: the 9/11 terrorist attacks and the 2008 Global Financial Crisis (GFC). It speaks volumes about how COVID-19 is viewed in regard to the potential impact on the US economy.
While the US equities market initially greeted the news of the rate cut with a rally, it didn’t last more than 15 minutes as worries began to mount. Fundamentally, the sudden rate cuts are a bad signal of how the Fed is viewing the outlook of the domestic economy. The S&P lost approximately 2.8 percent on during the second week of March.
On the other hand, the price of gold rose as safe-haven demand increased. Interestingly, the gold mining equities index also followed the physical metals, heading upwards, closing 3.7 percent higher. While the increase in the gold price is certainly encouraging to gold investors, speculators should be cautious for the following reasons:
- The gold price has failed to maintain an-above USD 1,650/oz level once again after hitting USD 1,652.8;
- While the gold mining equity index 3.7 percent higher, it still retreated by 3.4 percent at the close from the intra-daily highest point. This means that investors continue to take profits whenever there are opportunities.
Most important of all, after looking at the historical gold price performance seen during both the SARS period and the 2008 GFC, it is clear that it does not always rise during a catastrophic event, and it certainly doesn’t always rise in a straight line.
After the rate cuts, the market now expects there is a 54 percent chance that the Fed will cut another 25 basis points at the April meeting, according to Eikon’s feature, FedWatch. The market predicts that the US interest rates could fall to 0.413 percent by the end of 2020 – 76 percent lower than the 1.75 percent at the beginning of this year.
While the aggressive rate cuts are bullish on the gold price in the long run (assuming the market’s current expectation on the US rates is correct), gold could still be sold off if the financial market continues to be harassed by increasing margin calls and client redemptions in a market where tensions continues to rise. While cutting rates should propel the gold price, its performance during the GFC suggests that rate cuts cannot help the gold price in the short to medium term when the market panic level is at extraordinarily high levels. The Fed lowered rates seven times in 2008, cutting an accumulative 3.25 percent during the process, but it still took the gold price seven months to hit the bottom by October 2008.
The million-dollar question is: how deep an impact could COVID-19 have on the global economy, and could the impact be comparable to that seen during the GFC? We do not have the answer yet, but China’s Purchasing Manager’s Index for February has already dropped to 35.7 index points, a historical low since the Chinese government made this economic data publicly available.
In conclusion, investors who ignore the price fluctuations and are operating without leverage can simply buy gold at current levels, as it has been proven throughout history that once the liquidity squeeze is gone, gold will bounce back with vengeance. Those who operate with leverage may need to beware of the possibility that the gold price, and related equities, could fall off again sometime in the near future if market panic increases. Therefore, it is more prudent to buy on price weakness.
