Crude oil price continues to trade below 74 in European morning as stock markets weaken. In the UK, the FTSE 100 Index slides -0.2% to 4887 while Germany's DAX and France's CAC 40 lose around -0.1% to 5512 and 3648. In Asia, stocks also fell amid worries about credit tightening in China.
Currently trading at 947, the benchmark contract for gold maintains its sideways trading. The yellow metal has been moving below 1000 since February and the trading range has narrowed from 850-990 to 900-980 in recent months. Volatility has obviously reduced and the phenomenon is even more apparent in non-USD terms.
Rise in risk appetite and diminished inflation expectation are the main reasons for the recent boring gold price movement. As global economic outlook has turned brighter, investors tend to allocate more capitals to higher-yield assets such as stocks. Their interests in gold appear to have slowed down.
In 1Q09, the market talked about hyper-inflation which is expected to be brought about by the massive monetary and fiscal stimulus worldwide. However, very few people seem to care about it after policymakers including Fed Chairman Bernanke reinforced that inflationary pressure remained subdued.
For many years, analysts and policymakers have been using 'Taylor Rule' as a gauge for interest rate decisions. John Taylor, the economist who developed the well-known rule, said that too much variation in the rule may affect interest rate policy and the inflation outlook.
Taylor said that, using the original formula (interest rate = 1.5* inflation rate + 0.5* GDP gap + 1), the US inflation rate is about 2% and the GDP gap is about -8% while the interest rate should be 0%. This is similar to current Fed funds rate of 0-0.25%. Should inflation rise and GDP gap narrows, the Fed will increase interest rate early next year.
However, Fed Governor Laurence Meyer believed the rule should be amended from '0.5 * GDP gap' to '1*GDP gap' which implies an interest rate of -4%. In this case, the Fed will not raise its policy rate until end of 2010. Moreover, as policy rate is non-negative, the Fed may want to adopt additional stimulus measures in order to help 'revive' the economy.
If the Fed really underestimates economic outlook and keeps its policy rate too low for too long, this will affect inflation. That is, future inflation will be much higher than what is currently anticipated.