Quarterly Outlook
Fixed Income Outlook: Bonds Hit Reset. A New Equilibrium Emerges
Althea Spinozzi
Head of Fixed Income Strategy
Gold faces challenges amidst the backdrop of rising real yields
Ole Hansen
Head of Commodity Strategy
Summary: Gold continues to struggle, and by now the drift lower from the early May record high has seen it reach the lowest level in more than three months. Driven by US economic data strength supporting the hawkish stance laid out by the FOMC at their June meeting. Hikes that support the markets current belief the FOMC will be succesful bringing inflation under control, a situation that is driving inflation adjusted yields higher, thereby reducing the appeal of non-interest paying gold
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Key points in this gold update:
- Gold struggles and have reached a three-month low to trade near key support
- Market challenges conventional wisdom about yield curve inversion and recession
- Short-term demand for gold suffers but overall bullish outlook remains
Gold continues to struggle, and by now the drift lower from the early May record high has seen it reach the lowest level in more than three months. Driven by US economic data strength supporting the hawkish stance laid out by the FOMC at their June 14 meeting when members talked about the need for more rate hikes before year end. Data strength which at the same time is challenging conventional wisdom that a steeply inverted yield curve leads to a recession, and together with the market still pricing inflation below 2.5% within the next two years it has driven up inflation adjusted yields, especially at the front end of the curve, thereby reducing the appeal of non-interest paying gold.
On three earlier occasions during the past two decades at peak in US Fed funds rate supported a strong gold rally in the months and quarters that followed, but with the timing of such a peak being postponed, short-term demand for “paper” gold through ETFs and futures have suffered. Our table showing some of the biggest and most popular commodity ETFs highlights the recent exodus from gold. Total holdings in bullion-backed ETFs have seen a 42 tons reduction during the past month to 2888 tons, leaving it just 33 tons above a three-year low that was reached just before the March banking crisis triggered strong demand for havens, especially gold.
For now, the direction of gold continues to be dictated by movements in the dollar (as seen below) and developments in the short-term interest rate market where traders place bets on the direction of Fed Funds rates and those bets are currently pricing in one full 25 bps rate hike by November before the attention turns to rate cuts with the first now priced in for March next year. As such, it is not a forecast that should trigger the kind of negative response currently seen in gold, and it highlights the fact the market fear more hikes have yet to be priced in. Especially if inflation does not fall at a pace acceptable by the FOMC.
While the short-term technical outlook may deteriorate further on a break below $1900, the next key US economic print will be Friday’s PCE (Personal Consumption Expenditure) deflator, the Fed’s preferred inflation measure. The headline is expected to show a price-supportive drop to 3.8% from 4.4% last month, but with core inflation expected to show continued stickiness at an unchanged 4.7%.
While the short-term outlook remains challenged by the Fed’s prolonged battle with inflation, we keep an overall bullish outlook for gold, driven among others by the following expectations:
- Renewed dollar weakness as yield differentials continue to narrow.
- An eventual peak in Fed rates have historically provided some strong tailwind to gold in the months and quarters that follow
- Central bank demand look set to continue as the de-dollarization focus continues to attract demand from several central banks. One unknown is how price sensitive, if at all, this demand will be. We suspect it will be limited, with higher prices not necessarily preventing continued accumulation.
- We believe inflation is going to be much stickier with market expectations for a drop back below 2.5% perhaps being met in the short-term but not in the long-term, forcing a gold supportive repricing of real yields lower.
- A multipolar world raising the geopolitical temperature
- Low investor participation, recently reduced further, adding support should the above-mentioned drivers eventually supply the expected breakout.
From a technical perspective, gold stays in short-term downtrend following the break below earlier support around $1934. Next key area to watch is around $1900 with $1903 being the 0.618 retracement of the March to May 258 dollar rally while $1902 represents the 0.382 retracement of the whole move up from the November triple bottom low. For the technical outlook to deteriorate further, thereby raising doubt about our overall bullish outlook, the price needs to break back below the February low at $1805. A close above the 21-day moving average, currently at $1945 would be the sign of a change towards a more price favourable sentiment.
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