FxWirePro: Delta-hedging for yellow metal price risks on lingering FOMC’s hiking risks

The yellow metal price would usually be sensitive to moves in both UST rates and USD. The gold prices would be more expensive for holders of foreign currency on the robustness of dollar, while a rise in U.S. rates lifts the opportunity cost of holding non-yielding assets such as bullion.

The predominant driving forces of the gold price in long-term is confidence in the official money and in the institutions (governments, central banks, and private banks) that create/promote/sponsor the official money. While tomorrow’s FOMC decision should help determine the near-term trajectory.

Fed will hike more in order to keep inflation low: With inflation rising, the FOMC will be more confident in rising rates further towards, and finally above the neutral level, estimated at 2¾%. Our forecasts call for four hikes this year and the same number of hikes in 2019. We do not believe that the FOMC will signal so many hikes at this week’s meeting already

The US dollar continued to recover yesterday. The softness in currency is being supported above all by the monetary policy outlook, i.e. the hope of a more rapid normalization of US interest rates on the part of the Fed due to a quick rise in inflation.

Good ownership in front end Gold skews: With Gold front vols bound to remain firm for longer and as the late cycle Gold rally takes hold on the back of the late Fed, Gold skews should stay supported even as 3M skews are at the highest level since Aug 2017. Positively skewed IVs of 2m tenor have been well balanced that signify the hedging sentiments on either side.

We recommend buying delta-hedged 3M XAUUSD 25-delta risk reversals @ 1.3/1.6 vol.

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