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Gold prices drop sharply following optimistic Federal Reserve that could raise rates in 2023

Kitco News

The gold market is losing some ground as the Federal Reserve strikes an optimistic tone on the health of the economy and signals that interest rates could rise by 2023.

The U.S. central bank said that economic activity and the labor market have strengthened due to strong policy support and progress on vaccines.

Meanwhile, the Federal Reserve continues to reiterate its view that rising inflation will be transitory.

"The sectors most adversely affected by the pandemic remain weak but have shown improvement. Inflation has risen, largely reflecting transitory factors," the central bank said in its monetary policy statement. "Overall financial conditions remain accommodative, in part reflecting policy measures to support the economy and the flow of credit to U.S. households and businesses. The path of the economy will depend significantly on the course of the virus. Progress on vaccinations will likely continue to reduce the effects of the public health crisis on the economy, but risks to the economic outlook remain."

Gold prices have dropped sharply into negative territory, giving up all of their session gains. Prices have also pushed below critical initial support at $1,850 an ounce. August gold futures last traded at $1,844.20 an ounce, down 0.66% on the day.

However, garnering the most market attention is shifting expectations for interest rates. The projections, also known as the dot plots, show that the central bank is forecasting interest rates to be 0.6% in 2023, which would point to two interest rate hikes during the year. In March, the projections call for no rate hikes through 2023.

"The dot plot is the big early story," said Adam Button, chief currency strategist at Forexlive.com. "Seven FOMC members saw no hike in 2023, but 13 now do. What's even more striking is that seven now see at least one hike in 2022, which is as many there were for 2023 just three months ago. They've arguably moved the pace of hikes forward by a full year in just three months."

Summary of Economic Projections

Looking at growth, the Federal Reserve expects U.S. gross domestic product to increase 7.0% this year, compared to the previous forecast of 6.5%. Looking to 2022, the central bank projects that GDP will increase 3.3%, unchanged from March's forecast. Meanwhile, by 2023, GDP growth is expected to increase 2.4%, up from the previous forecast of 2.2%.

The U.S. central bank is also optimistic that the labor market will continue to recover after the devastation in 2020 due to the COVID-19 pandemic. For 2021 the unemployment rate is expected to fall to 4.5%, unchanged from March's reading. The unemployment rate is expected to be 3.8% for next year, down compared to the previous estimate of 3.9%. In 2023 the unemployment rate is expected to fall to 3.5%, unchanged from the previous estimate.

The U.S. central bank is also forecasting inflation pressures to build. The projections show that the Personal Consumption Expenditures Index (PCE) is expected to rise 3.4% in 2021, up from March's projection of 2.4%. Inflation pressures are expected to continue to grow in 2022, with PCE increasing 2.1%, up from March's estimate of 2.0%. In 2023, the Federal Reserve expects inflation to hit 2.2, up from the previous forecast of 2.1%.

Core inflation expectations, which strip out volatile food and energy prices, are expected to rise 3.0% this year, up compared to the previous estimate of 2.2%. Next year, core inflation is expected to moderate, increasing 2.1%, compared to March's forecast of 2.0%. In 2023, inflation is expected to rise to 2.1%, unchanged from the previous estimate.

Avery Shenfeld, senior economist at CIBC, described the Federal Reserve's monetary policy statement as it didn't address any potential reduction in the central bank's bond-purchase program.

The Canadian bank is also more hawkish on interest rates than the Federal Reserve.

"Neither a spike in inflation nor a Q2 growth rate that in our view could top 9%, could really shake the Fed that much from its dovish stance, although the latest news from the FOMC gives a subtle nod in that direction," Shenfeld said. "The only hawkish note is that the median fed funds forecast shows a 50 bp hike to 0.6% in 2023, versus a projection of no change in the last forecast. That's a step in our view towards a more realistic assessment of what monetary policy could look like, as we doubt inflation can remain so tame in 2022 with an unemployment rate below 4%. We have that half-point hike a year earlier, in H2 2022."

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