The Daily Market Report: Gold Firms on Geopolitical Tensions, Weaker Dollar

USAGOLD/Peter Grant/05-15-17

Gold firmed in early trading to slightly exceed last week’s high at 1236.51, before retreating into the range. The yellow metal was buoyed by an uptick in geopolitical tensions with North Korea and a retreat in the dollar as soft U.S. data weigh on rate hike expectations.

North Korea’s latest test of a missile has ratcheted tensions higher. “The test-firing of ICBMs will occur at any time and place, at the will of North Korea’s highest leadership,” vowed North Korea’s ambassador to China. The defiant tone in the wake of the test begs some kind of response from President Trump.

Soft U.S. data have further tempered rate hike expectations. Fed funds futures now put the probability at about 73%, down from a high of 89% just last week. That has prompted the dollar index to retrace much of last week’s gains.

In recent weeks we have scoffed at the Fed’s hints at balance sheet normalization. Bloomberg pointed out in an article that the Fed “alone financed roughly 40 percent of America’s budget deficit last year” via their reinvestment of maturing Treasuries on the balance sheet. They are going to need to show me a viable replacement for that demand — let alone the demand for anything they might actually sell — before I view balance sheet normalization talk as anything more than hawkish jawboning.

Whether the Trump reflation agenda gets implemented or not, deficits are expected to grow in the years ahead. The only way to replace the artificial Fed demand — and absorb the additional supply — is with the lure of growth crushing higher rates.

My guess is that the Fed will begin buying assets again, long before they can ever unwind the massive $4-trillion-plus balance sheet. It may just take a recession to get the central bank to make such a drastic policy shift.