Gold is staring down the barrel of surging yields and Fed's QT, can it handle it?
(Kitco News) It's just the second week of 2022, and gold is already looking at two major obstacles it needs to come to terms with — surging U.S. Treasury yields and Federal Reserve's quantitative tightening (QT). And now Goldman Sachs is warning of four rate hikes this year and balance sheet runoff as early as July.
Gold is already down 2% year-to-date as it trades below its key psychological $1,800 an ounce level. At the time of writing, February Comes gold futures were trading at $1,798.50, up 0.06% on the day.
After rising to around $1,830 an ounce during the first week of the year, things began to shift after the hawkish minutes from the December Federal Reserve meeting were released. According to the minutes, a "tight" U.S. labor market and problematic inflation could require quicker rate hikes and a balance sheet reduction.
"Participants generally noted that … it may become warranted to increase the federal funds rate sooner or at a faster pace … Some participants also noted that it could be appropriate to begin to reduce the size of the Federal Reserve's balance sheet relatively soon after beginning to raise the federal funds rate," the minutes said.
This is a major change to the monetary policy outlook, with big call makers like Goldman Sachs now pricing in an even more aggressive Fed.
The latest research note from Goldman's Jan Hatzius stated that the U.S. central bank is likely to raise rates four times this year and begin balance sheet runoff as early as July.
"We are … pulling forward our runoff forecast from December to July, with risks tilted to the even earlier side," Hatzius said. "With inflation probably still far above target at that point, we no longer think that the start to runoff will substitute for a quarterly rate hike. We continue to see hikes in March, June, and September and have now added a hike in December."
In response to a more hawkish tone, bond yields climbed to multi-year peaks, which is adding pressure on gold price action.
U.K.'s five-year yields rose above 1% on Monday, marking the highest level since March 2019. German 10-year yields were just three basis points away from the positive territory for the first time since May 2019. The U.S. Treasury yields also moved higher, rising to 1.806%.
"Yields continue to rise and many risk assets, equities and crypto continue to struggle," said Bannockburn Global Forex chief market strategist Marc Chandler. "The market has moved to boost the chances of a hike by the Fed in March and has begun leaning toward four hikes this year."
All eyes will be on the Federal Reserve Chair Jerome Powell's nomination testimony before the Senate on Tuesday and Fed Governor Lael Brainard's nomination testimony for the vice-chair position on Thursday.
"The Fed's balance sheet strategy is becoming more salient, and Powell/Brainard confirmation hearings and several FOMC voting members' speeches this week will be scrutinized for clues," Chandler pointed out.
Gold is sensitive to rate hikes and moves in bond yields, which is why Commerzbank analyst Daniel Briesemann sees gold holding up relatively well considering the current macro environment.
"We believe that the pressure on the Fed to raise interest rates is growing. According to remarks made by Fed Governor Waller, the Fed will be ending its bond purchases in mid-March and will already decide on a rate hike at its meeting on 15/16 March. U.S. bond yields climbed further to 1.8% in the wake of the labor market data, putting them at their highest level in almost two years," Briesemann said.
The latest inflation figure out of the U.S. is also a high priority for traders this week. The December data will be released on Wednesday, and market consensus calls are projecting the consumer price index rising to 7% on an annual basis.
"Rising bond yields and earlier anticipation of stimulus withdrawal dragged U.S. equities lower last week with the S&P 500 posting its worst start to a year since 2016," said Exinity Group chief market strategist Hussein Sayed. "Markets are anticipating another 40-year high for U.S. CPI when the figure is released. Consumer prices are expected to have increased to 7.1% year-on-year. Another surprise to the upside will possibly put more pressure on bonds, sending yields higher."
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Many gold analysts, including Capital Economics, ANZ and RBC are looking for gold to move towards $1,600 an ounce in 2022 as Fed begins to tighten its policy.
"We're not expecting much upside from current levels. The $1,800 level is essentially our Q1 target, which is barely above current levels," said ANZ senior commodity strategist Daniel Hynes. "And then, during the second half of the year, gold is likely to ease back and hit $1,600 by the year-end."
But some remain bullish on the yellow metal, citing more geopolitical concerns and gold's historically good performance at the beginning of previous rate hike cycles.
"While the U.S. central bank may be on track to raise rates, it will still provide an expansionary monetary policy. And, central banks will continue to buy gold, while investors are looking to diversify given a higher perceived risk of equity market volatility, suggesting that gold speculators' relative short positioning may still drive the yellow metal into the $1,850s/oz in the early months of 2022," said TD Securities head of commodity strategy Bart Melek. "But, while negative real rates along the curve should protect gold from a full-blown rout, the yellow metal is projected to trade in the mid $1,600s for much of H2-2022."
Gold can surprise with a 20% gain in 2022 as it reclaims its inflation hedge status, wrote Byron Wien, vice chairman of Blackstone's private wealth solutions business, and chief investment strategist Joe Zidle.
"The price of gold rallies by 20% to a new record high. Despite strong growth in the U.S., investors seek the perceived safety and inflation hedge of gold amidst rising prices and volatility. Gold reclaims its title as a haven for newly minted billionaires, even as cryptocurrencies continue to gain market share," Wien and Zidle wrote in Blackstone's annual 'Ten Surprises of 2022' post.