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Gold Q3 Forecast: Central Bank Hawkish Outlook Spells Trouble for XAU/USD

Gold Q3 Forecast: Central Bank Hawkish Outlook Spells Trouble for XAU/USD

Diego Colman, Contributing Strategist

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Gold Recent Market Drivers

In the second quarter, gold prices failed to maintain the upward momentum of the first three months of the year and were on track to fall by more than 3% heading into June’s close. The yellow metal came under pressure from rising yields and a reassessment of monetary policy expectations both in the U.S. and Europe in response to sticky inflation.

The chart below shows how the Federal Reserve’s tightening roadmap for 2023 repriced sharply higher and quickly after the brief slump induced by the turmoil in the banking sector back in March. As sentiment improved, nominal yields staged a strong rebound, with short-dated ones threatening to reclaim their peak from March.

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2023 Fed Funds Futures (Implied Yields)

Source: TradingView, Prepared by Diego Colman

image1.png

US Treasury Yields

Source: TradingView, Prepared by Diego Colman

image2.png

U.S. real yields, the true gauge of borrowing costs and gold’s kryptonite also surged, hurting rate-sensitive assets. The chart below, in which XAU/USD is displayed on an inverted scale to better appreciate the correlation, shows how bullion sank as the U.S. 10-year Treasury Inflation-Protected Security (TIPS) advanced.

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Gold Spot Prices Versus 10-Year TIPS

Source: TradingView

image2.png

Broader Fundamental Outlook

Market dynamics will not be favorable for gold in the near term. For instance, the Fed’s hawkish guidance, which implies 50 basis points of additional tightening through year’s end and higher-for-longer rates, is likely to act as a drag on precious metals moving into the summer. With nominal and real yields biased upwards, gold will remain in a vulnerable position, meaning that further losses could be brewing.

However, the outlook will not remain bearish for long. As the FOMC’s forceful hiking campaign works its way through the system, cracks will begin to emerge, as they did in back in March when two regional banks collapsed. While the U.S. economy has held up remarkably well, it will have a hard time withstanding rates above 5.0% for too long, especially at this stage of the business cycle.

Once signs of recession become evident and hard to ignore in the data, traders will begin to price in aggressive rate cuts by the central bank, sending the Treasury curve plunging lower and volatility soaring. At this point, falling yields, coupled with market turbulence, should support gold prices and set the stage for a strong rebound later in the year.

Timing the chain of events could prove difficult, but the steady rise in U.S. jobless claims – a leading indicator, suggests that the economy could be a couple of months away from buckling under the weight of excessively restrictive monetary policy. Under these assumptions, gold could hit a rough patch early in the third quarter but regain its poise by mid-summer when macro conditions take a turn for the worse.

This article only covers the fundamental outlook for gold prices. If you would like to learn more about technical forecast and price action analysis, download DailyFX’s complete quarterly guide by clicking the link below. It's free!

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DailyFX provides forex news and technical analysis on the trends that influence the global currency markets.

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