If the Federal Reserve is forced to embrace negative interest rates, the gold price will react by breaching the previous all-time high of $1,920 an ounce, according to Standard Chartered.
Fed Chairman Jerome Powell has been adamant that negative interest rates are not the right tool to use in the U.S.
In his latest comments on Friday, Federal Reserve Chairman Jerome Powell reiterated his thoughts on negative interest rates, stating: “We don’t think it is an appropriate tool for the U.S.,” adding that the evidence of how negative rates work is mixed.
But markets remain unconvinced that negative rates will not be employed in the U.S. in the future.
“Markets saws the fed funds dipping briefly and very gently (1-2bps) into negative territory in mid-2021 before returning to positive territory (4-7bps) in mid-late 2022. We see this small move into negative rates as reflecting a strong market belief that the Fed will be on hold for an extended period. If the market is convinced that there is no room to raise rates, it will likely price in some probability of rates falling, however remote,” Standard Chartered explained.
The bank also highlighted that it does not see negative rates as its baseline outlook, but if the Fed is forced to go negative, it will have to go deep into the negative territory to make an impact.
“If the Fed takes the Fed funds rate negative, it will likely take it 50-100bps negative. In our view, this is a much bigger risk than the Fed dipping a policy rate toe into negative waters … A negative policy rate is not our baseline scenario and would occur on a disappointing rebound and exhaustion of other policy measures, but we see little point to a small move,” stated Standard Chartered.
The effect of negative rates on gold could be massive with prices potentially breaching record highs of $1,920 an ounce, said the bank’s precious metals analyst Suki Cooper.
“Gold prices would likely test levels beyond the previous intra-day high of USD 1,920/oz, as negative interest rates would lower the opportunity cost of holding gold. Investors still appear to be under-allocated to gold, and negative rates could draw interest from retail to the official sector,” Cooper wrote on Friday.
Negative rates in the U.S. could open gold up to new types of investors, increasing gold’s demand, added Cooper.
“Much of the negative-yielding debt globally has been driven by Europe, where investors have chosen to increase their exposure to gold through physically-backed ETPs or gold coins and bars, even when investors were disinvesting in gold in the U.S,” Cooper wrote.
On the other hand, the U.S. dollar could be looking at a sharp drop once the dust settles.
“Negative rates could disrupt short-term money markets at first, so the initial response might be buying G10 safe havens, or even result in USD strength. Once the surprise element passed through the market, currencies with positive yield and muted fiscal policy should prosper,” said Standard Chartered.
On top of that, the U.S. Treasury yields could see new all-time lows across the entire curve, Standard Chartered added.
“We would expect a Fed policy rate 50-100bps below zero eventually to pull UST yields negative at least out to the 10Y maturity. We would expect the lower policy rate to drag down the 10Y real yield component,” the bank noted.