(Kitco News) With all eyes on the Federal Reserve next week following Friday’s hot inflation data, analysts see gold in a good position to surprise investors to the upside.
Friday’s U.S. inflation number showed the fastest annual pace in nearly 40 years, up 6.8% in November. The reaction to the data was somewhat mixed as some parts of the report hinted at price pressures potentially peaking.
“Wall Street did not see inflation with a 7-handle, and that allowed risky assets to rise, while the dollar turned negative as traders anticipate the Fed won’t be forced to deliver a rate hike well before summer,” said OANDA senior market analyst Edward Moya. “November’s headline month-over-month CPI reading increased 0.8% was higher than the 0.7% estimate but lower than the prior month’s reading of 0.9%. Some of the inflation is moderating, but the year over year reading came in at 6.8%, the hottest since 1982.”
The inflation number was the determining factor behind how aggressive the Federal Reserve could be on December 15. And since the Fed Chair Jerome Powell’s hawkish stance to accelerate tapering has already been priced in, markets will be keeping a close eye on other hawkish language, the dot plot and economic projections.
However, markets’ anticipation of aggressive rate hikes might be too premature since the Fed remains largely boxed in, said TD Securities head of global strategy Bart Melek.
“The reality is that gold has already responded to Powell telling us he is speeding up the taper from $15 billion to most likely $30 per month. He is also not as comfortable using the word transitory when referring to inflation. But despite that, on balance the Fed is now somewhat more dovish than it was before, especially after Powell’s renomination and the decision to nominate Lael Brainard as Fed vice chair,” Melek told Kitco News.
It’s important to keep in mind that Powell choosing to retire the phrase “inflation is transitory” does not mean he believes inflation is here to stay.
“Powell believes that inflation is here to stay for a little longer, but it is going to start moderating. For gold, it is incredibly important to remember that just because they are tapering a little quicker, it does not necessarily mean that they are ready to pull the trigger on rate hikes. The benchmark for raising rates is much higher — full employment. U.S. Treasury Secretary Janet Yellen believes that you need to run the economy hot in order to increase capacity,” Melek explained.
The CME FedWatch Tool is pricing in a 43.3% chance of a first rate hike in June. But Melek warned that it might be too soon.
“My view here is that they are not lifting rates in June. And inflation is starting to look like that the pace of acceleration momentum is reducing. When we look into the next few months, we likely won’t see gasoline prices up as much as we did the last month. We are also likely to see some relief in used vehicles. If that is true, then inflation has peaked, and I think the gold market is starting to suspect that,” he noted.
For gold, a more patient Fed is a good thing, which is why Melek sees gold trading higher next week. “The best case for gold is elevated inflation but decelerating inflation pace. Under those conditions, the FOMC will not be in any hurry to pull the trigger on the Fed’s fund rate. A speedier reduction of liquidity could also postpone the need to increase policy rate. Real yields will continue to be quite low,” Melek added.
Gold’s recent trading range of $1,760 and $1,800 is looking to hold up well next week, said Moya, noting that the precious metal has been getting is mojo back.
“A lot of the inflation is stickier than anyone wants, and that should keep gold’s medium- and- long-term outlooks bullish. Gold just needs to survive a firm consensus on how many rate hikes the Fed will start off with next year. An accelerated rate hiking cycle is a big risk and could trigger panic selling that could prove troublesome for gold in the short-term, but that still seems unlikely to happen,” he said.
Next week’s price risk is to the upside for gold, said Melek. “The $1,790-95 is a reasonable level we can be at.”
Data to watch
Some of the bigger releases to watch next week will be Wednesday’s Fed meeting and the U.S. retail sales. On Thursday, the European Central Bank is making its interest rate decision and the U.S. industrial production is being released.
“The U.S. calendar sees the Federal Reserve FOMC meeting, retail sales and industrial production. With no opposition raised by other Fed officials despite the uncertainty presented by the emergence of the Omicron variant, next week’s meeting look set to see the Fed announce an acceleration in QE tapering. We expect a $30bn reduction for January (to $60bn of purchases) and a further $30bn reduction in February with no further purchases in March onwards,” said ING chief international economist James Knightley.
The Fed’s dot-plot projections will also be carefully watched. “As recently as March, the FOMC dot plot suggested that interest rates were unlikely to increase until 2024. The June update moved this to 2023 and then in September the median expectation was for a 2022 move. Next week’s update from the Fed is set to show them shifting to a two-hike view for next year,” Knightley added.
Other data to keep an eye on will be Tuesday’s PPI numbers, Wednesday’s NY Empire State manufacturing index, and Thursday’s building permits and housing starts, jobless claims and the Philadelphia Fed manufacturing index.
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