Gold and the taper menace
Another USD900bn fiscal package in the US in December (with the prospect of more to come) as well as the mass deployment of effective vaccines against the pandemic have induced markets to start discounting an early tapering of the Federal Reserve’s bond-buying programme. However, we do not expect a ‘taper tantrum’ of the magnitude of the one that badly hurt gold prices back in 2013.
First, the Fed would like to avoid undue tightening of financial conditions. The US central bank is likely to be very careful about any tapering decision given the US budget deficit has ballooned in recent months. Indeed, we believe the Fed is engaged in a form of implicit yield-curve control, keeping a lid on long-term US nominal rates. Second, the Fed’s monetary framework has changed since 2013. Last year, the Fed introduced an ‘average inflation targeting’ framework, suggesting that in the absence of strong and sustained inflationary pressure for some considerable time—perhaps not until 2025.
Finally, major central banks’ monetary policies are broadly synchronised today--unlike 2013, when the Fed was the only major central bank in a position to normalise its monetary policy. While some central banks may take more time to normalise than others, a radical divergence in monetary policies looks unlikely in the coming quarters. Furthermore, while the greenback was undervalued in 2013, this is not the case today. In a nutshell, strong appreciation of the US dollar looks highly unlikely in the coming months.
Our central scenario is that the US 10-year real rate will stay around its current low level (-1.0% on 26 January) in the first half of this year, suggesting continued support for gold. Indeed, we see scope for real rates to remain in negative territory for even longer. Nonetheless, with the US 10-year breakeven inflation rate already very low, there may also be limited room for US 10-year real rates to go much lower. Indeed, we believe the US 10-year real rate could rise towards -0.7% in the second half of the year.
To sum up, we are sticking to our thee-month projection for gold of USD1,950 per troy ounce and our six-month projection of USD2,050, as a very cautious Fed will continue to help depress the rise in long-term nominal rates. However, we are adjusting lower our 12-month projection to USD2,050 (from USD2,150 previously), as even a moderate rise in US 10-year real rates from very low levels may weigh on the gold price.