To Hike or Not to Hike? That is the Question the Federal Reserve Must Answer

The sentiment had been predominantly in favor of a pause in interest rate hikes. However, that had reversed after a couple of Federal Reserve officials came out with exceedingly hawkish comments last week which questioned the resolve of the Fed to pivot from an extremely aggressive monetary policy in which they have raised interest rates at every consecutive FOMC meeting for over a year.

Rate Hike Probabilities and Gold

Gold futures traded to the lowest low of $1953.80 since hitting $2000 per ounce last week. As of 5:42 PM EDT, gold futures basis most active August 2023 contract is up $8.50 or 0.43% and fixed at $1978.10. The dollar was in essence neutral today trading fractionally lower currently down 0.02% and fixed at 103.935.

However, today the Institute for Supply Management released the ISM report for May. The report revealed that the ISM services index came in lower than expected at 50.3 for the month. The report also revealed that the service sector in the United States hardly expanded last month resulting in a contraction of new orders falling from 51.9 in April. Expectations and forecasts predicted that today’s report would come in above April’s reading of 51.9 with a forecast of 52.2.

According to the Institute For Supply Management, “ The ISM® Report On Business® – Manufacturing (PMI®) and Services (PMI®) – are two of the most reliable economic indicators available, providing guidance to supply management professionals, economists, analysts, and government and business leaders. The reports are issued by the ISM Manufacturing and Services business survey committees.”

The lower reading made a strong case for the Federal Reserve to not raise rates at the FOMC meeting this month. It strengthened the probability that the Federal Reserve will not raise rates at the next FOMC meeting

The probability that the Federal Reserve will implement its first interest rate hike pause since March 2022 has strengthened considerably over the last week. One week ago, the CME’s FedWatch indicated that there was a 35.8% probability of a rate pause, on Friday the probability surged to 74.7%, and today there is an 81.8% probability that the Fed will pause hikes after 10 consecutive rate hikes at each FOMC meeting since last year.

This action was highly supportive of gold which traded under strong selling pressure on Friday and today as gold trading resumed in Australia, Hong Kong, and London. However, all of this changed when the report was released in the United States in the morning.

Technical Analysis

On a technical basis, today’s low effectively filled a gap that was created that occurred between May 30 and 31^st. The gap that was created on a continuous futures chart which merges most active contracts and will typically have a price gap because of the differential in the bid-ask spread between the two contract months. The reason contract months that contain more time are more expensive is contango. Contango is a situation where the futures price of a commodity is higher in months with more time until expiration. Contango usually occurs when an asset’s price is expected to rise over time, as well as storage costs. This results in an upward-sloping forward curve.

That is exactly what occurred at the end of last month. Because gold futures hit a high of $2000 just last week that is the current level of major resistance.

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Wishing you as always good trading,

Gary S. Wagner