One of the biggest headwinds for select areas of the stock market in recent months has been interest rates. With uncertainty over when the Fed will begin cutting interest rates, rate-sensitive sectors like utilities have underperformed the S&P while metals like gold have had difficulty mounting a sustained advance despite having other fundamental factors in their favor.
However, that dynamic could be on the cusp of a major reversal in favor of rate-sensitive investments as the likelihood increases that interest rates will soon fall.
Indeed, the interest rate picture has decidedly cleared up as traders now assign a nearly 100% probability the Fed will cut interest rates at its September policy meeting. Specifically, they see the central bank lowering the fed funds rate by a quarter percentage point to 5% to 5.25% in September, from the current 5.25% to 5.50%, according to the CME FedWatch tool.
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Even more provocative is the prospect the Fed could shock the market’s expectations by lowering rates at next week’s July 30-31 policy meeting. As it turns out, a small but growing minority of economists and analysts think this is a distinct possibility.
Jan Hatzius, top economist at Goldman Sachs, made the case that the Fed should start cutting rates this month instead of waiting until September. In a recent note to investors, Hatzius said that U.S. inflation has cooled off enough to warrant loosening policy imminently.
On that score, the well-known Wall Street economist Scott Grannis has opined that the latest domestic inflation data allows the Fed to start cutting “sooner and more forcefully” than September. He writes: “Inflation has been licked, and interest rate sensitive sectors of the economy are really hurting. Lower rates would provide welcome relief, and it would take a whole lot of cuts to add up to any meaningful stimulus.”
Recent stock price action suggests the market may already be pricing in an aggressively looser interest-rate policy in the coming months. This includes the sudden burst of strength this summer in rate-sensitive areas of the market like regional bank, utilities and even gold.
As far as buying gold is concerned, record purchases of the precious metal by China’s central bank have been a major tailwind for it over the past two years. While China’s reasons for aggressively accumulating gold haven’t been entirely clear, observers agree that geopolitical concerns over the Russia/Ukraine conflict are one likely motivation.
In May and June, however, China’s gold-buying spree suddenly stopped. That left investors worried that perhaps the gold market had lost valuable support for keeping its uptrend intact. But the inverse relationship between gold and interest rates and the expectation that interest rates will soon fall has replaced central bank buying as a key catalyst for gold’s rising trend.
Historically, gold performs exceptionally well when rates are in decline, so if the Fed begins cutting rates this summer as expected, gold bulls will have a fresh impetus for maintaining control of the dominant trend.
Meanwhile, for investors who currently have no exposure to the metal but want to be positioned for falling interest rates, you might consider owning a conservative position in a gold-backed fund like the iShares Gold Trust (IAU), which holds physical gold bars in secure, segregated and allocated storage—including fractional bars—or a similar gold ETF.
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