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Gold price looks to the Fed as focus shifts to 2023 rate hikes - analysts

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(Kitco News) There are signs that gold has found a bottom after a streak of weekly losses, according to analysts. Now, the focus is shifting to the Federal Reserve's rate announcement on Wednesday, which will include updated economic projections as well as the new dot plot.

Analysts are not expecting any significant policy changes as markets are starting to wonder if the U.S. could see sooner-than-expected rate hikes due to strong economic growth and rising yields.

"How officials see the economy and rates heading over the upcoming years is crucial for investor's decision making," said FXTM chief market strategist Hussein Sayed.

Addressing rising yields

The last time the Fed updated its economic and rate hike projections was in December, and a lot has changed since then, analysts said. The Fed's December estimates saw the U.S. GDP growing by 4.2% and the unemployment rate declining to 5% by the year-end.

Analysts see these forecasts being revised to the upside. "Compared to December, there is a clear path to an upgrade with stronger growth, lower joblessness, and faster inflation. BMO Economics is now looking for 7% real GDP growth this year," said BMO Capital Markets managing director for commodities research Colin Hamilton.

Market participants also see inflation rising faster than the Fed's outlook, especially in light of quickly advancing U.S. Treasury yields.

"Massive stimulus combined with fast vaccination rollouts and low-interest rates are all seen as ingredients for rising prices. Inflation expectations have soared over the past three months, with five-year breakeven rates rising to 2.6%, the highest since 2008. U.S. 10-year Treasury yields are now trading above 1.6% and some market participants are betting the benchmark could reach 2% before year-end," according to Sayed.

So far, Fed Chair Jerome Powell has been ignoring rising yields and playing down increasing inflation expectations, stating that any price acceleration will be temporary. But this will have to be addressed eventually, said BBH Global Currency Strategy. "The Fed will have to address this move higher in rates before it snowballs into something it can no longer control," they wrote on Monday.

Investors will be carefully watching if there has been a shift in the Fed officials' thinking. "There have been no signs that they are ready to step in. So far, implementing yield curve control does not seem to be on the table, but whether the Fed will shift its asset purchases to more long-dated bonds remains a question to be answered on Wednesday," Sayed said.

Sooner-than-expected rate hikes?

December's dot plot projections had only one Fed official anticipating a rate hike in 2022. Only five out of 17 officials expected higher rates by 2023. This left the median forecast showing no interest rate hikes through 2023.

If that number changes to the upside, a rate hike in 2023 will be more likely, added Sayed.

December's projections are looking "dated," especially considering the new $1.9 trillion fiscal stimulus, said Bannockburn Global Forex managing director Marc Chandler. "Looking at the implied interest rate of three-month Eurodollar futures, the market appears to be pricing in the first hike in the second half of next year," Chandler said.

The Fed's updated median could reflect at least one rate hike by the end of 2023, added Hamilton.

Gold's price action

Wednesday's Fed announcement will be a key driver for the precious metals sector this week, analysts noted. And after losing more than $200 since the start of the year, there are signs that gold could be done selling off.

"Gold gained noticeably in the late hours of trading on Friday and recouped its initial losses after having dropped back for a time to $1,700. Gold was thus able to chalk up its first weekly increase in four weeks," said Commerzbank analyst Carsten Fritsch. "This could mean that it is beginning to bottom out."

ETF outflows in gold are also starting to stabilize. "They totaled less than 30 tons last week after averaging 47 tons in the two previous weeks," Fritsch pointed out. "Friday saw outflows of only 1.6 tons, the lowest daily figure in four weeks."

At the same time, gold continues "to be held hostage by Treasury markets as the Fed's reactive approach to the steepening in rates will continue to lead to investment outflows from the complex," said TD Securities head of global strategy Bart Melek.

At the time of writing, April Comex gold futures were trading at $1,723.00, up 0.19% on the day.

The current correlation between yields and gold is that as yields go up, gold comes down. This can change in the future, and once it does, gold can surge higher, said RJO Futures Senior commodities broker Daniel Pavilonis.

"Eventually, that correlation will break. The Federal Reserve admitting that we are seeing inflation and we might have to raise rates sooner than thought would break that correlation. Or even just admitting that rising yields are a concern. That would be bullish for gold," he said.

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