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Fed's next move defines what gold price does next after volatile drop to pandemic levels

Kitco News

(Kitco News) Gold's volatility rocked the market this week as critical support levels broke and prices tumbled towards $1,650 an ounce. However, what the precious does next will depend on the language Federal Reserve Chair Jerome Powell uses at the central bank's monetary policy meeting next week.

Gold saw an $80 move this week, tumbling to $1,661 — the lowest level since April 2020. December Comex gold futures were last trading at $1,682.60, down 2.7% on the week.

"Gold slumped amid expectations of more aggressive rate hikes by the Fed … after data showed demand for workers in the U.S. remains strong. Retail sales were also reasonable. This is likely to keep the Fed on the tightening cycle for the foreseeable future."

Fed rate hike expectations

Expectations of a 75 basis point rate increase on Wednesday and then another 75 bps hike in November are weighing heavily on gold as the U.S. dollar and Treasury yields continue to climb.

"Strength in the broader economy removed the safe-haven appeal from gold. Meanwhile, rate hike expectations are driving up the real rate interest, which is not favorable to gold. The more the Fed hikes, the more gold will see weakness in the short term," said Gainesville Coins precious metals expert Everett Millman.

An even deeper retreat in gold is not ruled out, noted OANDA senior market analyst Edward Moya.

"If the Fed surprises with 100bps next week, we are looking at $1,600 breaking and the outlook for gold getting worse. But policymakers are likely to stick to a 75bps increase," Moya told Kitco News. "But markets should be prepared for the U.S. central bank to retain this pace into the November meeting. And that will keep gold under pressure."

The economy needs to show signs of a slowdown for gold to begin its recovery. But for now, the incoming macro data show a labor market that is still strong.

"If the economic data deteriorates in the next couple of months, the Fed is likely to downshift," Moya added. "We also need to see inflation decline. The Fed has a balancing act to worry about. It can't take rates to 5% or much higher without feeling a lot of pain."

Some analysts, however, are much more bearish on gold going forward. TD Securities extended its tactical short position in gold on Friday, citing rising risks of a capitulation event.

"We initiated the trade in anticipation that a repricing in Fed expectations will exacerbate ongoing outflows in the yellow metal amid increasingly persistent inflation ... Our analysis suggests gold prices aren't pricing in the next stage of the hiking cycle," said TD Securities Senior Commodity Strategist Daniel Ghali. "We expect continued outflows from money managers and ETF holdings to weigh on prices."

TD Securities' new gold target level is $1,580, with a stop-loss order at $1,720 an ounce.

The path of least resistance remains down for gold, even though a pause in volatility is the most likely scenario after the selloff, said RJO Futures senior market strategist Frank Cholly.

"Major support is now closer to $1,650. It is the level for markets to test if the buyers are ready to step in," Cholly told Kitco News. "The market has now priced in 75bps next week and possibly another 75bps after that. Maybe Powell will say something during the Q&A on Wednesday that would ease the fear that the Fed will overdo it. Gold will like that. We can't continue to raise rates without giving the economy time to show further evidence of a slowdown.

If the Fed wants a soft landing, it will have to slow down on the rate hikes, he added.

Yield curve inversion

There is also a yield-curve inversion to worry about next week. A yield curve inversion happens when shorter-term Treasury rates move above longer-term yields. The market often considers the inversion of the 2-year and 10-year yield curve as a reliable preemptive sign of a recession down the line. And it has been getting worse.

The yield on the 10-year Treasury was last at 3.46%, while the yield on the 2-year Treasury was at 3.88%. The yield gap is now at minus 42 basis points, the deepest in a month.

"We're observing a textbook FX reaction to the U.S. yield curve inversion: a supported dollar, and heavily impacted pro-cyclical/commodity currencies … Slumping oil prices (third consecutive weekly drop) are all part of the equation and are mirroring how markets are factoring in a more aggressive tightening by central banks materially hitting global demand," said ING FX strategist Francesco Pesole. "This is just another factor delaying any correction in the dollar."

Next week's data

Tuesday: U.S. building permits, housing starts

Wednesday: Fed rate decision + economic projections, U.S. existing home sales

Thursday: BoE rate decision, U.S. jobless claims,

Friday: Fed Chair Powell speaks

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