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(Kitco News) - As the Federal Reserve kicks off its two-day monetary policy meeting, it is all but a given that interest rates will be 25 basis points higher Wednesday afternoon.
However, for many commodity analysts, the question holding back gold is whether this will be the Federal Reserve's last rate hike in its most aggressive tightening cycle in more than 40 years. According to the CME FedWatch Tool, markets see only a 20% chance of another rate hike in September.
At the same time, markets see a nearly 56% chance of interest rates holding between 5.25% and 5.50% through the end of the year.
Some economists and analysts have said that falling inflation pressures give the Federal Reserve room to pause raising interest rates. Last week, the U.S. Bureau of Labor Statistics said that its Consumer Price Index rose 3.0% year-over-year last month, the smallest advance in more than two years. At the same time, core inflation also cooled more than expected, rising 4.8% for the year in June.
"Despite the ‘higher for longer' rhetoric from officials, a more marked decline in core inflation and easing in labour market conditions in the second half of this year will eventually persuade the Fed to pivot and cut rates aggressively next year," said Paul Ashworth, chief North America economist at Capital Economics.
The market's expectations for the Fed to end its tightening cycle are at odds with the central bank's projections. Last month, economic projections showed that the committee was looking for two more rate hikes this year.
Some analysts have said this gap between the Fed's forecast and market expectations could weigh on gold prices in the near term as the tightening cycle has not yet finished.
"There is a great chance that the Fed will spoil your mood if you are among those thinking that this week's rate hike will be the last for this tightening cycle in the US," said Ipek Ozkardeskaya, senior analyst at Swissquote Bank.
However, some analysts also note that while the central bank may talk tough, its bark might be worse than its bite at this point. Many analysts have said that while interest rates have room to move higher, there is a limit to how high they can go as economic activity starts to soften.
"While we anticipate that July will bring the Fed's last rate increase of this cycle, we do not think the Fed is comfortable signaling that shift just yet," said market analysts at TD Securities. "Policymakers appear more comfortable maintaining a hawkish stance for now."
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Other analysts see a more nuanced stance in the marketplace and think gold could be an attractive currency play. Some analysts note that inflation in the U.S. has fallen a lot more compared to other regions like the United Kingdom and Europe. While the Federal Reserve has room to shift its hawkish stance on monetary policy, the Bank of England and the European Central Bank don't.
"If other economies continue to tighten their monetary policy – the European Central Bank seems certain to raise rates this week while the jury is still out on whether the Bank of Japan will tighten its policy in the light of its recent bout of relatively high inflation – this may lessen the relative attraction of the US dollar," said Jonathan Butler, head of business development at Mitsubishi. "This could ultimately benefit USD-denominated precious metal prices."
Nicky Shiels, metals strategist at MKS PAMP, said she sees potential for gold as the Federal Reserve's monetary policy is unlikely to support the U.S. dollar.
"We think the markets are itchy looking for reasons to sell the US$ and while [Federal Reserve Chair Jerome Powell] will indicate the inflation fight is not over, the market will look through to any dovish comments and understands well that the Fed is at the end of its hiking cycle," she said. "The ECB rate hike trajectory is relatively more murky - inflation has begun to fall, but whether that's enough to persuade Lagarde to pause (or stop) after this week, is less certain."
Lukman Otunuga, senior market analyst at FXTM, said that whatever the Fed does, investors should expect to see some significant volatility Wednesday.
"A solid breakout above $1970 could trigger a push towards $1985 and $2000, respectively," he said. "Should prices slip back below the 50-day Simple Moving Average around $1947, bears may target $1940 and $1932."
At the same time, many analysts also recommend investors look past gold's short-term volatility and focus on the broader long-term landscape.
Many analysts have said that while inflation has fallen sharply from last year's 40-year highs, it's still unlikely the Fed can bring it all the way back down to its 2% target. Analysts have noted that gold remains an attractive inflation hedge with interest rates close to their peak and consumer prices stubbornly elevated.
In a recent interview with Kitco News, Sean Lusk, co-director of commercial hedging at Walsh Trading, said that he sees gold as a strong buy on dips.
"Yes, gold prices can drop $50 next week if the Federal Reserve maintains a hawkish bias after the rate hike," he said. "But there is little they can do about inflation. You have a bunch of commodities that have no place to go but up because of supply issues. There are all sorts of scarcity in a broad range of commodities," he said.
