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FED TO STIR VOLATILITY IN USD, GOLD & STOCKS – TALKING POINTS

  • Volatility across asset classes appears ready to climb higher as traders gear up for the June 18-19 Fed meeting
  • USD downside could accelerate and send spot gold higher driven by a dovish Fed
  • Gold prices threaten to advance alongside a drop in stocks if Chair Powell and the FOMC take a firm stance on rates
  • Check out IG’s Client Sentiment Tracker for real-time trader positioning data in the US Dollar, gold and the S&P 500

Hopes for global economic growth rebounding later this year are quickly fading. Market fears have been fanned by the growing uncertainty surrounding US trade policy on the back of an ongoing Sino-American trade spat and the latest threat of Trump levying tariffs on Mexico. Although, the recent hit to risk assets in response to these developments has since reversed as traders beef up bets that the Federal Reserve (Fed) will cut rates and shore up sentiment to sustain the US’ record-setting economic expansion.

As expectations for a dovish Fed balloon, cross-asset volatility has faded. With markets currently pricing in 3 rate cuts by the end of 2019, however, the risk of investor complacency threatens to stoke additional price action in currencies, gold and stocks – particularly if the FOMC and Chair Powell shock markets with a firm stance on monetary policy this Wednesday.

SPOT GOLD (XAUUSD) VS CURRENCY MARKET VOLATILITY (FXVIX)

Spot Gold Price Chart and Currency Volatility

According to FXVIX – an equally-weighted index of Cboe’s 30-day implied volatility readings on the Euro (EUR), Pound Sterling (GBP) and Japanese Yen (JPY) – currency market volatility has ebbed from its spike following the influx of global uncertainty in late-April. Owing to expectations that the next Fed meeting will reveal a move towards looser monetary policy mirroring other central banks, these risks appear to have been placed on the backburner for now.

While hopes for a dovish Fed have temporarily boosted appetite for risk and curbed a sharp rise in FXVIX, yields on US debt remain subdued as traders seek safety in treasuries due to fears over slowing global growth. This theme of lower interest rates while the Fed and investors react to adverse shocks to the economy, in addition to a weakening US Dollar (USD) from easier Fed policy, are expected to continue bolstering spot gold (XAUUSD) while propelling additional FX and gold price volatility.

US DOLLAR INDEX (DXY) VS GOLD PRICE IMPLIED VOLATILITY (GVZ)

Gold Price Volatility and US Dollar Index Chart

The steep slide in the greenback over the last 3 weeks, as measured by the DXY US Dollar Index, has been matched by a sharp jump in Cboe’s 30-day implied gold volatility index (GVZ). FXVIX and GVZ threaten to skyrocket higher on the prospect of USD continuing its decline on the back of a dovish Fed, which tends to benefit gold prices as history shows.

But, it is noteworthy that USD faces upside risk from safe-haven demand as several market uncertainties still linger in the back of investors’ minds. Moreover, the risk that Chair Powell and the FOMC shocks markets with a firm stance on monetary policy could also send USD snapping back higher.

SPOT GOLD TO S&P 500 INDEX RATIO VS STOCK MARKET VOLATILITY (VIX)

XAUUSD to SPX ratio chart and VIX overlay

Yet, spot gold has potential to still catch a bid despite headwinds faced from a potential rebound in the dollar. Judging by the relationship between the ratio of XAUUSD to the S&P 500 Index (SPX) and Cboe’s 30-day US Equity Market Volatility Index (VIX or “fear-gauge”), gold tends to broadly outperform stocks as investor fear – measured by the VIX – rises.

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That being said, the willingness of Chair Powell and FOMC members to shore up the economy with loose financial conditions risks failing to satisfy the market’s lofty rate cut expectations. Disappointing markets could push VIX on a path towards notching another near-vertical ascent as it did back in December 2018 while gold prices similarly move higher – even as the USD gains.

- Written by Rich Dvorak, Junior Analyst for DailyFX

- Follow @RichDvorakFX on Twitter