(Kitco News) Gold breached $1,900 an ounce Thursday as inflation cooled. But whether or not the metal can maintain gains depends on the rate hike expectations for the Federal Reserve's February meeting.
In an impressive move higher at the start of the year, gold is already up around 4%, with February Comex gold futures last trading at $1,902.10 an ounce. And since the November lows of around $1,618, gold is up around $280.
One of the main drivers behind the bullish trend has been the macro outlook, which includes cooling inflation, a slowing economy, and the anticipated pivot by the Federal Reserve.
To get gold to $1,900 an ounce, traders needed to see inflation start to meaningfully come down, which is exactly what happened with the December figures. Annual inflation during the last month of the year decelerated to 6.5% following November's pace of 7.1%. The yearly core CPI also slowed to 5.7% from 6%.
"The deceleration continues after headline had peaked at 9.1% year-on-year in June and core at 6.6% YoY in September," said ING's chief international economist James Knightley. "The last three months of data are a notable step down."
25 bps vs. 50 bps in February?
This is precisely the evidence the Fed needs to start slowing down. Following the CPI report, the market began to price in a 96.2% chance of a 25 basis point increase in February versus the 50 bps hike, according to the CME FedWatch Tool. Just a few weeks ago, those expectations were split nearly in half.
"There is enough here for the Fed to opt for a 25bp hike in February," Knightley said. "Nonetheless, given the strength of the jobs market, officials will remain cautious and likely heavily hint at a further 25bp hike in March."
Federal Reserve Bank of Philadelphia president Patrick Harker said Thursday the U.S. central bank could accomplish its task with slower rate hikes.
"I expect that we will raise rates a few more times this year, though, to my mind, the days of us raising them 75 basis points at a time have surely passed," Harker said. "In my view, hikes of 25 basis points will be appropriate going forward."
St. Louis Fed President James Bullard also noted Thursday that it was "encouraging" to see inflation go in the right direction. "So far, so good. My bottom line for 2023 is that it will be a year of disinflation," Bullard stated.
However, it might be too early for the Fed to declare victory on inflation just yet, said Wells Fargo's economists Sarah House and Michael Pugliese.
"The increasingly compelling evidence of slowing inflation brought by today's report ups the chance that the FOMC will hike the fed funds rate by just 25 bps at its next meeting, but with the trend in inflation still above target, we expect that even if the FOMC delivers a downshift in pace, it will continue tightening past its next meeting," House and Pugliese said Thursday.
After so many inflation surprises over the past two years, some market participants could be waiting for more proof before adjusting positions.
"On one hand, declining inflation numbers are significant. But on the other hand … the strength in core services CPI is a niggling problem for the Fed," said MKS PAMP metals strategist Nicky Shiels. "The current gold trajectory is pricing in closer to 25bp, so if 50bp expectations grow (and this is now contingent on the mix of Fed speakers on later this week), the bullish trajectory needs to reprice to a less bullish trajectory and perhaps test recent floors / inflection points ($1,850)."
Is gold pricing in Fed rate cuts already?
Many on Wall Street and Main Street are pricing in rate cuts later this year as the economy begins to slow. And the gold market could be anticipating that.
"With both the manufacturing and service sector ISMs in contraction territory, the National Federation of Independent Business optimism survey below the low point hit in the pandemic and the Conference Board's measure of CEO confidence at its weakest level since the depths of the Global Financial Crisis the prospects for the economy are not looking good," Knightley added. "With inflation slowing rapidly and recession looking inevitable, the second half will witness meaningful rate cuts, possibly as much as 100bp."
The yield curve is "screaming recession," DoubleLine Capital CEO Jeffrey Gundlach said during his 'Just Markets' webcast Tuesday.
"The 3-month to the 10-year became inverted not long ago. The 10-year yielded more than 200 basis points than the three-month bill," Gundlach said. "We see that we have exactly the setup that goes all the way back to the Volcker days. We haven't seen the 3-10s this inverted since the early 1980s. It was close in 1999-2000. But that was a pretty nasty recession that ensued."
According to him, the Fed will have trouble getting rates up to 5% and will be forced to cut this year. "The bond market pricing shows that the Fed is not going to make it to 5%. They're going to make it just under 5% by May or June and then start cutting," he said.
The DoubleLine Capital CEO turned bullish on gold after it crossed the $1,800 an ounce level, and he believes "it's a reasonably good time to buy gold and own gold."
Gold is the new bull trend on the idea that the markets have already seen peak Fed hawkishness, noted Shiels.
"Markets will continue to look through the noise to find that Fed pivot story," she said Thursday. "The trend is for a weaker US$ and well bid precious metals. Gold is currently internalizing what is going to happen in 2023. There will be a Fed slowdown, a Fed pivot, a recession, and then finally a liquidity injection, where the money supply will ultimately rise again in 2023."
