Gold got a boost following the Fed’s rate decision and managed to poke above $2,000/oz briefly on Thursday. But resistance seems to have been sufficiently strong to keep price action below that level. Given the latest turmoil in the markets and the change in the Fed’s position, is there a fundamentals reason for gold to break through? Or can we expect resistance to hold out?
The change at the Fed
The initial reaction from the market was that the Fed had pulled off a “dovish” hike. The increase in the interest rate was according to expectations, but the policy statement changed the language from “ongoing rate hikes” to “some additional firming” of the interest rate. This was widely interpreted as opening the door to a pause. In fact, for the moment, most traders are currently forecasting no rate hike at the next Fed meeting.
Fed Chair Powell’s comments afterward, in which he took a decidedly more hawkish stance, reverted that situation a bit. The dot-plot of forecasts from FOMC members showed that their expectations for rates hadn’t changed, despite the chaos in the banking sector. Powell’s comments were in those lines, suggesting confidence in the backstop for banks meant that the Fed could keep up fighting inflation.
What does that mean for Gold?
Although Powell talked tough, the market is once again not believing him and the rate forecasts of the FOMC members. Not only is the market effectively pricing in a pause, but it’s also pricing in a drop in rates this year. That’s much to the contrary of what the Fed is saying. The market is once again believing that the Fed will be forced to cut rates to deal with a building recession.
That’s extra good for gold this time around. Usually, recessions are a good time to have gold, as investors flock to safe havens. But, over the past year or so, that hasn’t been the case because the Fed was still expected to keep hiking as inflation came down. That meant that holding treasuries, which pay dividends, was a better investment than gold, which doesn’t pay dividends.
It comes down to inflation expectations
But now that the Fed is expected to quit hiking while inflation is high, the logic that had kept gold from advancing over the last year or so is fading. If inflation is expected to remain high for a long-ish period of time, holding gold is a good option. Even if Treasuries do pay interest, if the interest rate is below the inflation rate, then holding gold is more profitable.
Interest rates are still below inflation at the moment, and if the Fed actually does quit fighting inflation over economic growth concerns, then inflation could remain elevated for a long time. Treasury yields have come down substantially as investors pile into safe havens ahead of an expected difficult period for the markets. That also reduces the attractiveness of treasuries compared to gold.
What that means is that the fundamentals are lining up to push gold higher – as long as the markets are correct in their assessment of the Fed. If the banking situation calms further over the next six weeks, and expectations return for the Fed to keep tightening, then gold could lose its mojo. Gold traders would do well to pay close attention to yields, and particularly the 2-year yield, over the coming weeks.