Quarterly Outlook
Fixed Income Outlook: Bonds Hit Reset. A New Equilibrium Emerges
Althea Spinozzi
Head of Fixed Income Strategy
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Gold traders holding their breath ahead of FOMC
Ole Hansen
Head of Commodity Strategy
Summary: Gold has spent most of December trading rangebound with an underlying tone of weakness since November 22, after surprisingly hawkish Powell and Brainard acceptance speeches, raised the prospect for a much sooner than expected lift-off in US rates. Today's FOMC should give us some answers and with inflation running red hot, expectations for a very hawkish outcome has created a sense of unease across markets
Gold has spent most of December trading rangebound, with the 200-day moving average around $1793 offering strong resistance. The yellow metal has been on the defensive, with an underlying tone of weakness since November 22, after surprisingly hawkish Powell and Brainard acceptance speeches helped trigger a sharp sell-off.
The combination of surging inflation, recently hitting 6.8%, the highest since the 1980’s, and both FOMC members having been read the riot act by the White House, has driven a clear change in focus at the Fed from job creation to combatting inflation. The encouragement from the White House being driven by Biden’s slump in the polls as millions of Americans are getting hurt by rapid rising prices of everything from fuel to food and housing.
There is no doubt the FOMC will deliver a hawkish outcome tonight, but how the market will react is not straight forward. In his latest update titled “The Fed expectations conundrum”, our Head of FX Strategy, John Hardy discussed three potential scenarios, and how the market may react to each of them.
Being the most interest rate and dollar sensitive of all commodities, gold may see a strong reaction to the outcome, and given the price behavior in the run up to the announcement, traders have moved to the side of caution. Driven by worries that the FOMC may opt for what John Hardy calls the hawkish case, where the Fed delivers a doubling of the speed of tapering by $30 billion or faster. Doing that would leave the door wide open for the Fed to move forward the lift-off date to March from current expectations for June.
Ultimately gold’s direction will, as mentioned, be determined by the response in long-end yields and the dollar. The outlook for 2022 remains clouded with most of the bearish gold forecasts being driven by expectations for sharply higher real yields. Real yields have throughout the past few years shown a high degree of inverse correlation with gold, and it’s the risk of a hawkish Fed driving yields higher that currently worries the market.
However, with three rate hikes priced in and with gold trading at levels which look around 0.25% too cheap relative to 10-year real yields, the downside risk should be limited unless the Fed turns up the rhetoric and signals a more aggressive pace of rate hikes.
It is also worth keeping in mind that rising interest rates will likely increase stock market risks with many non-profit high growth stocks suffering a potential revaluation. In addition, concerns about persistent government and private debt levels, increased central bank buying and the dollar rolling over following months of strength, are all potential drivers that could offset the negative impact of rising bond yields.
At this point gold remains on the defensive and only a break above the mentioned 200-day moving average can change that. So, barring any sudden change gold will be heading for its worst annual performance in dollar terms since 2013.
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