Quarterly Outlook
Fixed Income Outlook: Bonds Hit Reset. A New Equilibrium Emerges
Althea Spinozzi
Head of Fixed Income Strategy
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Gold rally slows as Fed pause gives a boost to risk sentiment
Ole Hansen
Head of Commodity Strategy
Summary: Global markets felt relieved last night after the Fed Chair Powell sent a strong hint to the market that the Federal reserve is done hiking rates. Following on from a weaker than expected ISM manufacturing print earlier in the day, Powell’s message helped boost sentiment across markets that recently have been plagued by geopolitical concerns, sharply rising Treasury yields driving the risk of economic weakness and a mixed earnings season. Precious metals, however, responded relatively subdued to the prospect of a peak in rates which would normally be seen as supportive for investment metals. In this update we take a closer look at why that may lit in store.
Global Market Quick Take: Europe
Key points in this note
- Risk sentiment improves after Fed Chair Powell sent a strong hint that the Federal Reserve is done hiking rates
- Gold could be short-term challenged by an improved sentiment and after rallying 200 dollars in a short space of time
- Central bank demand heading for another record year with focus on ETF investors and when they may return as buyers
Global markets felt relieved last night after the Fed Chair Powell sent a strong hint to the market that the Federal reserve is done hiking rates. Following on from a weaker than expected ISM manufacturing print earlier in the day, Powell’s message helped boost sentiment across markets that recently have been plagued by geopolitical concerns, sharply rising Treasury yields driving the risk of economic weakness and a mixed earnings season. Precious metals, however, responded relatively subdued to the prospect of a peak in rates which would normally be seen as supportive for investment metals.
The Fed left rates unchanged at 5.25-5.50%, in line with expectations and market pricing while there were only slight changes to the FOMC statement and the door for further rate hikes was left open. Growth expectation was changed from ‘solid’ to ‘strong’ and there was some acknowledgement of higher longer-end yields, with tighter financial conditions mentioned alongside tighter credit conditions. However, Powell was clear that the Fed was not thinking about rate cuts yet.
The reason gold did not shoot back above $2k on the news was the fact bullion had already travelled a long distance within the past few weeks. And while the rally initially was triggered by the unrest in the Middle East and wrong-footed short sellers in the futures market, we believe the bulk of the near 200-dollar rally was fueled by the continued surge in US bond yields with traders and investors growing increasingly concerned about US fiscal policy, and especially whether the recent jump in both real and nominal yields would end up ‘breaking something’. That focus triggered an unusual situation where rising bond yields, and with that also dollar strength ended up supporting gold.
Total holdings in bullion-backed ETFs have been falling continuously for many months with asset managers continuing to focus on US economic strength, rising bond yields and potentially another delay in peak rates as reasons for not getting involved. These together with the rising cost of funding a non-interest paying precious metal position has been a significant driver behind the year-long reduction in gold positions, which is now finally showing signs of reversing, and we believe renewed interests for ETFs when it occurs will be the trigger for higher gold prices. Such a change will occur either when we see a clear trend towards lower rates and/or an upside break forcing a response from real money allocators for ‘fear of missing out’.
For a second year running, strong central bank demand also helps explain why gold has not behaved ‘normal’, rallying to a near record during a period of surging US real yields, higher cost of carry, a strong dollar, and heavy ETF selling. A recent article in the FT showed how central banks are likely to test last year’s all-time high for gold buys this year, with the buying being led by emerging markets looking to reduce reliance on the US dollar for reserves holding. According to the World Gold Council, central banks led by China have bought 800 tonnes in the first nine months of the year, up 14 per cent year-on-year, and provided we see another strong fourth quarter, last year's record above 1000 tonnes could be breached.
With US treasury yields showing signs of stabilizing and potentially softening a touch, we may see normal relations between bullion and yields reestablishing itself, and while peak rates will add support to gold in the months ahead, the continued journey towards higher prices will be challenged by usual periods of consolidation and corrections. For now, however, with multiple geopolitical uncertainties still supplying some support, we believe any short-term correction will be short lived and shallow.
Gold has paused after rallying almost 200 dollars last month after profit taking emerged once again above $2000 per ounce. Having rallied so hard in a short space of time the market needs consolidating, but so far, the correction has been relatively shallow with support appearing at $1953, ahead of $1933, the 200-day moving average and 38.2% retracement of the mentioned rally. Given the length of the recent rally gold can correct back below and $1900 without damaging the bullish setup, while a fresh break above $2000 may give traders the confidence to push it higher towards the $2050 level.
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