Gold survives tightening moves but can this continue?

Gold prices slumped to a 4-week low ahead of the Fed’s decision but managed to hold above the $1800/oz level as the central bank didn’t spring any surprises. Despite the recovery, gold ended the week lower with a decline of nearly 2 per cent.

US inflation data released earlier this month showed that consumer prices rose at the fastest pace in 40 years. The sustained rise in price pressure fueled expectations that the Fed may fasten the pace of monetary tightening.

Gold fell sharply early this week as market players positioned for a big move by the Fed. True to market expectations, the Fed raised interest rate by 0.75% to 1.5-.75% on June 15, its third consecutive and second incremental hike after raising lending rate by 0.25% in March and by 0.5% in May.

The Fed also laid the path for more hikes. Fed projections show the possibility of the interest rate rising to 3.4% by the end of the year, which is 175 basis points higher from the current midpoint. The Fed has four more scheduled meetings this year. So there is a possibility of more moves. Fed Chairman Jerome Powell indicated that a 50-basis points hike or a 75 basis points hike is possible at the July meeting. He, however, tried to calm market nerves by stating that oversized rate hikes may be rare.

Gold is a commodity which yields no interest. Hence, it tends to underperform during rising interest rates. The Fed’s move this week shows that the central bank is keen on getting rising prices under control and may not change its stance unless there is a significant improvement in the inflation situation.

While the Fed’s monetary tightening stance is negative for gold, the metal has benefitted from increasing uncertainty about the global economy and increasing challenges for the US dollar. The increasing emphasis on inflation has also increased gold’s appeal as an inflation hedge.

Monetary tightening is expected to reduce liquidity and boost borrowing costs which may slow down economic activity. The Fed has lowered its GDP growth forecast till 2024 and also expects inflation to edge up. The 2022 GDP growth forecast has been cut from 2.8% to 1.7%, while the unemployment rate is inching up to 3.7% against the previous estimate of 3.5%.

The US dollar index jumped to 2002 high earlier this week amid positioning ahead of the Fed decision but has struggled for direction since then. The US dollar has turned choppy as the Fed’s monetary tightening stance is countered against the hawkish stance of other central banks. The US dollar is also challenged by a weakening outlook for the US economy.

Central banks across the globe are under pressure to get inflation under control and we have seen quite a few surprise moves in the last few days. Earlier this month, the Reserve bank of India and Reserve Bank of Australia surprised with bigger than expected rate hikes. Then the Fed also announced a sharp hike in interest rate. The next surprise move came from Swiss National Bank, which surprised with a 0.5 per cent hike against market expectations of no change. The Bank of England raised interest rates as expected, but the divided decision fueled expectations that bigger moves may be considered. The latest surprise move came from the Bank of Japan, who decided to continue with accommodative monetary policy to support economic growth, despite tightening by other central banks and increasing pressure on Japanese Yen.

Gold has also benefited from the sense of panic triggered by abrupt changes in central bank policies and increasing uncertainty about the global economy, which has caused investors to shun riskier assets and look for alternatives.

Gold has managed to survive the Fed scare but may continue to struggle for direction as support from global growth worries and inflation concerns will be offset by the tightening stance of major central banks, which may keep yields higher. The next major event will be the Fed Chairman’s testimony on monetary policy. The central bank chief may have to justify the frequent changes to monetary policy while inflation remains out of control.

(Madhavi Mehta is the AVP- Research of Kotak Securities)

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