Although the beginning of 2017 is showing a striking resemblance to 2016 from the perspective of gold and the US dollar, several developments are conspiring to change the stakes for both assets. While the fading Trump rally has left some market participants confused as to the outlook, especially with details on policy notably absent from recent speeches, recent data suggests the pace of policy tightening is set to accelerate.
Comments from key Federal Reserve policymakers seem to suggest the risks of expanded fiscal stimulus and greater deficit spending is inflationary upside, a development that would trigger a shortened time frame for additional rate hikes. With the Fed’s dual mandate already reached, additional upward momentum in consumer prices would lead to a faster pace of tightening, creating tailwinds for the dollar that could invariably sap gold’s most recent gains.
Inflation Raises Normalization Potential
A significant portion of the gains in the US dollar over the last few months can be attributed to President-elect Donald Trump’s election victory. Promises of fiscal stimulus in the form of infrastructure spending combined with comprehensive tax reform and talk of trade tariffs was enough to send the US dollar index to the highest point in 14-years. However, after reaching a new peak at the start of 2017, the US dollar has since found itself under pressure as investors question whether or not Trump can deliver on his proposals. Standing in his way is resistance from both the Democrats and within his own party.With very few details on how he plans to accomplish his ambitious goals, the dollar rally has taken a serious pause.
However, Trump is the not the only driver of the dollar and thereby precious metals. The Federal Reserve should also play an important role in the conversation considering the economic backdrop and the outlook for monetary policy. Remarks from key Fed officials seem to indicate that many are wary of the impact of fiscal stimulus, believing it will lead to higher inflation and thus necessitate a faster pace of rate hikes. Classically, the US dollar benefits from policy tightening in the form of rate hikes, suggesting that despite a correction from the most recent rally, there remains significant upside potential considering anticipation of three hikes during 2017.
