FxWirePro: Cost-effective hedges for gold against dollar and euro on FOMC hiking cycle and geopolitical risks

Gold prices plunged during Asian and early European trading session ahead of today’s US Fed’s monetary policy, dipped from the day highs of $1,295.96 to $1,291.94 but managed to recover to the current $1,294.84 levels as the day progressed. Typically, bullion market prices are sensitive to the dollar prices and the US monetary policy.

The US Federal Reserve is unlikely to disappoint the market tonight. It is expected to raise rates by 25bps, moving the target range up to 1.75-2.00%. If this occurs, attention will shift to the future. The committee’s last set of forecasts in March showed a pretty even split over whether to raise rates three or four times this year. However, economic developments since then have increased the odds that the Fed will raise four times and we expect that to be reflected in the ‘dot plot’ of members’ median interest rate forecasts.

The US 10yr treasury yield rose during the London morning, from 2.94% to 2.98%, later reversing to 2.96%, while 2y yields rose slightly from 2.52% to 2.54%. Fed fund futures were little changed and continued to predict a rate hike on Wednesday and another by year end. While the US dollar index is up 0.3% on the day. 

XAU/EUR-XAU/USD call switch as a low-cost hedge for European political risk: In the aftermath of the recent dollar rally XAU/USD-EUR/USD implied correlations richened to new historical highs.

In case of adverse European developments Gold/USD is expected to remain broadly stable even in event of dollar gains (pressure lower on Gold from the strong dollar would likely get offset by stronger demand for an alternative reserve asset), while EUR would come under pressure and net underperformance vs XAU.

The above chart demonstrates the historical performance of XAU/EUR-XAU/USD call switches well during vol stress and during periods of XAU-EUR correlation consolidations by virtue of the XAU/EUR-XAU/USD structure being short the correlation.

Effectively, buying XAU calls/EUR puts vs. selling XAU calls/USD puts is a proxy for short EURUSD exposure but at zero-cost.

We recommend buying 3M XAU/EUR (strike 1111.0, ref fwd 1111.0454) vs. selling XAU/USD (strike 1305.0, ref fwd 1306.4099) call switch, pays 5bp XAU. Courtesy: JPM

Currency Strength Index: FxWirePro's hourly USD spot index is inching towards 74 levels (which is bullish) while articulating (at 12:30 GMT).

For more details on the index, please refer below weblink: http://www.fxwirepro.com/currencyindex

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