In a statement released last month, Federal Reserve members sounded pretty upbeat about the economy. They stated that the labor market had “strengthened,” and that the economy seemed to be gaining traction.
They also stated “near-term risks to the economic outlook have diminished,” and that “household spending has been growing strongly.”
After that announcement, many market participants thought a rate hike in September was a real possibility.
But everything changed last week, when the GDP growth for second quarter was released.
The data showed the US economy grew only 1.2%, way below the 2.6% Wall Street was forecasting. Based on the market reaction to the news, this surprisingly weak data could have important implications in the coming months.
The Fed Has Another Reason to Do Nothing
One of the most important factors holding back the US economy is weak business investments. In other words, companies are not investing in plants, property, and equipment. The Fed had already expressed concern about this problem in the past.
And now the most recent data has confirmed this could continue to hurt the economy. The GDP data showed the economy experienced the largest drop in business investment since the end of the Great Recession.
And with all the uncertainties surrounding the Presidential election, many companies may choose to wait for the election results before they decide to ramp up investments.
All that might keep the Fed from hiking rates this year. After the release of the GDP data, market expectations for the next Fed hike plunged. The Fed funds futures market indicated just a 34.4% chance of a rate rise this year. This is incredible considering that at the beginning of this year the Fed was anticipating four rate hikes.
And things could get worse. Some analysts are already warning of a possible recession. We’re already seeing red flags in the restaurant industry. Sales at restaurants and bars have fallen in three of the last six months. This could be a leading indicator for the rest of the economy because when consumers start to cut down on spending, eating out is typically one of the first things to go.
In fact, analysts at Stifel Financial Corp. believe the weak restaurant consumer spending seen in the second quarter of the year “reflects the start of a U.S. restaurant recession.” They also warned investors that “if history is a guide…restaurant-industry sales tend to be the ‘canary that lays the recessionary egg.’”
While this is all bad news for the economy, it’s great news for precious metals. Just look what happened when the weak GDP numbers were released.
After the disappointing U.S. economic growth data was released, gold prices jumped 1.2%. The weak data is good for gold because it decreases the chances of a rate hike soon. As you know, gold becomes more attractive to investors when interest rates are low.
The weak data also helped push the US dollar lower. The dollar index, which measures the performance of the dollar against six other currencies, dropped 1.3% to 95.5. Since gold tends to move in the opposite direction of the US dollar, this is also good news for the yellow metal.
If the economy continues to struggle, the Fed could considerably delay its next rate hike. And that could push the US dollar even lower in the coming months.
As you can see below in Fig. 1, the U.S. Dollar Index has been moving sideways since early 2015. It has been trading in a range between 93 and 100.
The key question here is: Is this sideways movement just a pause before another move higher? Or is this the end of the US dollar rally that started in 2014?
If the greenback weakness persists and the index breaks below 93, it could be a strong indication that a new downtrend in the U.S. dollar has started. And this could give a big boost to gold.
So keep an eye on the upcoming economic data and how the US dollar index reacts. This could determine the next big move in gold.
Courtesy: Tim Smith
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