Gold Price Forecast: Easing Financial Conditions Leave the Fed in a Tricky Spot

Gold Fundamental Forecast – Bearish

• Gold prices slowed for a second week, is momentum fading?
• All eyes are on the Fed, will the central bank bow to markets?
• Skew for XAU/USD seems biased lower on disappointment

Gold’s rally since October has been nothing short of impressive considering the underlying fundamental landscape. That said, this past week offered a slowdown for the yellow metal. XAU/USD is up about 5.7% so far this month, but the past 2 weeks have seen stagnation. Still, despite prices slowing, the yellow metal is on a 6-week winning streak. That is the longest since the summer of 2020.

With that in mind, considering the recent slowdown, has gold run too far and could prices reverse in the week ahead? All eyes are on the next Federal Reserve interest rate decision, due on Wednesday at 19:00 GMT. After hiking rates by 50-basis points, the consensus is that the central bank will tighten by just 25bps as headline inflation continues slowing. That would bring benchmark lending rates to 4.5 – 4.75%.

The problem here for gold is that markets could be getting ahead of themselves. Since the beginning of this month, traders have added almost 2 more rate cuts looking 2 years out – see chart below. This is on top of a pivot priced in for later this year. As a result, financial conditions have eased, pushing up stock markets and crucially, sinking the US Dollar. Longer-term Treasury yields have also pulled back slightly.

When the dollar and bond yields are falling, this is a prime environment for gold. The yellow metal is often referred to as the ‘anti-fiat’ instrument. It has no inherent yield for someone holding the asset outside of anticipated appreciation. As such, when the return on cash diminishes (as in traders price in Fed rate cuts), gold tends to benefit and vice versa.

Do easing financial conditions bolster near-term inflation expectations? Data since 2007 seems to show that this is inconclusive by looking at breakeven rates. That being said, the Fed may grow worried about easing financial conditions when inflation is still far above target. This opens the door for the central bank to keep the focus on near-term tightening. As such, the risk for gold might be skewed to the downside in the week ahead.

Market Outlook on Fed Rate Hikes - Now Versus End of December

--- Written by Daniel Dubrovsky, Senior Strategist for DailyFX.com

To contact Daniel, follow him on Twitter:@ddubrovskyFX