Gold likely to rally after Fed hints at “slow down” amid GDP contraction
LONDON (Aug 1) Gold prices were bolstered with the publication of preliminary data showing the contraction in US GDP in Q2, driving the yellow metal to close above the $1750 mark for the first time since July 5th, 2022.
Combined with historic levels of inflation, the yellow metal saw the return of safe-haven demand with prices rising 3.8% in the week from 25th to 31st July, marking the second week of positive price action, the first such occurrence since May 2022.
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Gold investors and traders who gauged that gold had suffered overselling benefitted from a renewed bullishness that saw a +4.3% shift in price from a low of $1709.1 on the day of the FOMC meeting.
In previous months, prices were depressed relative to fundamentals due to the elevated dollar resulting in a decline of 5.9% in the past 3 months despite the rally in the past 2 weeks.
Fed parks in ‘neutral’
The recent upswing in gold has been fueled by the Fed’s announcement last week. Governor Powell expressed his belief that the monetary position had been brought in line with the ‘neutral’ rate, a theoretical point where the price of money is no longer encouraging the economy to expand or contract. Leading economists in the US have inferred that this lies around 2.4%.
With the Fed having reached the neutral zone, Chairman Jerome Powell noted “it will be appropriate to slow down.” Although in his speech, he stated that the FOMC will make its decisions “meeting by meeting”, market watchers expect a loosening of monetary policy. This is likely because of the cracks beginning to slowly emerge in the labour market, declining business expenditures, and a further contraction in Q2 GDP.
Financial assets that pay out higher rates are naturally considered more attractive than gold which pays no interest. This is why the Fed’s softer tone on rate hikes proved beneficial for gold.
Although Powell cautioned that markets should be prepared for the possibility of an “unusually large” hike during the September meeting, subject to fresh macroeconomic data, most financial players do not seem convinced with the Fed’s rhetoric at this point.
Edward Moya, a senior market analyst at OANDA stated that “The risk of a full-percentage rate hike by the Fed is long gone.” ING economist James Knightley added that he was unsurprised that Chair Powell chose to be “vague” and expects the Fed “to pivot to 50 bps hikes in September and November.”
Daniel Pavilonis, a senior commodities broker, expects capital to flow into gold and remarked that “The Fed is signalling that it is not going to be as hawkish on rates as they have been…Gold is off to the races now.”
Fed rates will determine the direction
On the 21st of July, gold fell marginally below $1680, before rebounding to its current levels. Seasoned traders consider this to be a key technical support level in the near term.
For gold to break out more permanently, TD Securities’ suggests that the yellow metal must head above $1785, registering a high on Friday, 29th July which was just shy of this level at $1,784.60. Markets will be watching closely to see if this marker is breached in next week’s trading.
The primary threat to rising gold prices is the prospect of additional rate hikes by the Fed. With both the CPI (9.1%) and the personal consumption expenditures price index (6.8%) registering four-decade highs, monetary authorities may feel pressured to continue tightening.
Having said that, the Fed’s tightening has thus far had no impact with inflation only continuing to tick higher. On the contrary, Stiglitz and Baker make the case that raising rates further could be harming the economy even in the short run. This is because inflation appears to be primarily a supply-side issue, which will continue to be sticky for the foreseeable future until real-world bottlenecks are resolved.
Jeff Clark, the Senior Precious Metals Analyst at GoldSilver.com notes the inversion of the 2y10y yield curve signals an oncoming recession and has proved to be a “bellwether indicator” of economic downturns. He expects that a sharp fall in economic activity and a weaker labour market will force the Fed to slow the pace of rate hikes, and even reverse course, i.e. to start cutting rates by the spring of 2023.
During the 1970s, when inflation was running hot in the USA, Clark finds that “there was a delay from when inflation spiked and from when gold (and silver) prices moved.” The surge in gold prices lagged the CPI peak by nearly a year. This suggests that the bulk of the rally that is expected due to inflation may be yet to materialize.
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