The trend in the US dollar has been one of the key price determining factors for gold and this relationship remains intact as market players try to assess Fed’s monetary policy stance.
The US dollar index rose sharply last week and tested a 1-month high. The US dollar index edged up amid ongoing debate about the Fed’s monetary policy stance and amid increased safe-haven buying on the back of geopolitical tensions and growth worries.
The Fed has raised interest rates aggressively since March to get inflation under control, however, the central bank has now entered an uncertain phase as some improvement in the inflation situation and increasing pressure on economic activity has fueled debate about future moves.
The US inflation situation still remains out of control which means that rate hikes may continue however the July reading showed some improvement.
On other hand, mixed economic data shows increasing stress on the economy, and this has fueled expectations that the central bank may slow down the pace of rate hikes.
The Fed uncertainty was evident from the latest FOMC minutes as well as comments from Fed officials. FOMC minutes showed that the central bank wants to avoid inflation from becoming entrenched but also wants to avoid a situation of overtightening and sees the need to slow down rate increases at some point.
Some Fed officials have maintained support for aggressive rate hikes to control inflation while some believe that the pace of hike is subject to debate.
The general market expectation is that the Fed may raise interest rates by a smaller 50 basis points at the upcoming meeting in the month of September.
We may see continued volatility as market players react to economic numbers and central bank comments to determine future moves.
The US dollar index edged up also amid increasing concerns about the health of the European and Chinese economy. Both Europe and China are facing severe power crises which have worsened the economic outlook.
Europe is also struggling with higher inflation. Euro-zone consumer prices rose at a record pace last month while UK inflation hit double-digit for the first time in 40 years.
China is also in focus as virus-related restrictions have hampered economic activity while the property market remains under stress.
The Chinese central bank’s move to cut key lending rate and government’s efforts to boost infrastructure spending has also failed to improve the outlook for the economy.
Tensions rose further this week as China opposed the proposal of trade talks between the US and Taiwan. Adding to tensions, Indonesia announced that the Russian and Chinese President may attend the G20 summit in the month of November.
While the US dollar has been the preferred safe haven asset, increasing growth risks and geopolitical tensions are positive for gold as well.
Inflation concerns may also increase gold’s appeal as an inflation hedge. The power crisis in Europe and China threatens to worsen the inflation situation in the region.
Gold’s biggest challenge is a lack of investor interest. Gold ETF investors have continued to move out despite the recent fall in the gold price to March 2021 lows and despite the rebound above $1800/oz level.
Gold holdings with SPDR ETF are at the lowest level since January. Investors lack confidence as the Fed and other central banks are raising interest rates aggressively and may continue to tighten unless inflation comes under control.
Gold has weakened after four weeks of gains which shows that market players need fresh positive triggers to revive buying interest.
The US dollar index has bounced back with confidence but may remain volatile as there is increasing uncertainty about Fed’s monetary policy.
The next major trigger for the US dollar may come from the annual Jackson Hole Symposium where the Fed Chairman may discuss the US economic outlook and Fed’s monetary policy stance.
(The author is Associate Vice President – Commodity Research at Kotak Securities)
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