(Kitco News) - The gold market is ending another week in negative territory as investors prepare for the Federal Reserve to raise interest rates next week.
However, according to some analysts, gold’s ability to hold new support at $4,300 an ounce is an indication that the threat of an imminent rate hike is losing its potency. Spot gold last traded at $4,354.90 an ounce, down 1.7% on the week.
What some economists have described as the final nail in the coffin in favor of a rate hike next week was August’s Consumer Price Index, which showed core inflation, which strips out volatile food and energy prices, rising 2.4% over the last 12 months. Although consumer prices have not accelerated, they remain well above the Federal Reserve’s 2% target.
Headline inflation increased 3.4% over the last 12 months, unchanged from July.
“There’s no guarantee that the Fed will hike next week, but it’s hard to see how the central bank can justify leaving rates on hold,” said Chris Zaccarelli, Chief Investment Officer for Northlight Asset Management, in a comment to Kitco News.
According to the CME FedWatch Tool, markets see a nearly 90% chance of a rate hike next week.
However, analysts warn that the U.S. central bank has a bigger problem to worry about than just inflation. Growing U.S. government debt is starting to take its toll on the U.S. bond market, with yields holding at their highest levels in three years and pushing toward 5%.
Yields remain elevated even after the U.S. Treasury Department bought more than $5 billion in long-dated bonds Thursday. The disappointing buyback comes as U.S. debt has pushed above $40 trillion.
In a comment to Kitco News, Jeff Sarti, CEO at Morton Wealth, said that in this environment, the Federal Reserve is unable to aggressively raise interest rates.
“The Fed can put up a fight, but given our fiscal situation, they only have so much room to raise interest rates, so inflation will likely remain elevated from here,” he said. “The more important factor is our ever-deteriorating fiscal situation, and the bond market is sending a message that is loud and clear.”
Naeem Aslam, Chief Investment Officer of Zaye Capital Markets, said that gold remains well supported as the Federal Reserve’s credibility is starting to be tested. Last month, in his speech at the annual Central Bank Symposium in Jackson Hole, Wyoming, Federal Reserve Chair Kevin Warsh reiterated that his focus and commitment were on price stability and bringing inflation down to the central bank’s target.
“Basically, if the Fed increases interest rates, the Treasury yields will still not be satisfied, and if they don't, then it is their credibility that will be questioned,” he said. “So staying long gold is the name of the game right now.”
Ryan McKay, Director of Commodity Strategy at TD Securities, said in a note Friday that gold’s downside risks are growing ahead of the Federal Reserve’s monetary policy decision Wednesday, but he sees limited downside.
“Strong data and a hawkish Fed may only catalyze relatively modest near-term selling via systematic funds, while the renewed dollar-debasement theme, elevated central bank buying and renewed ETF accumulation offer a strong support base for longer-term discretionary flows. Any near-term weakness in the yellow metal should be increasingly viewed as a potential buying opportunity,” he said.
Ryan McIntyre, President of Sprott Inc., said he is not convinced that the Federal Reserve is ready to raise interest rates next week, and could remain neutral, using the fact that much of the inflation is being driven by higher energy prices caused by the ongoing war with Iran as justification.
However, he added that even if the central bank raises rates, the gold market is prepared. He pointed out that with prices below $4,400, a 25-basis-point hike is mostly priced in.
“More or less anything that they do will be relatively meaningless in the bigger picture,” McIntyre said. “They’re either going to accelerate things or slightly decelerate things, but the end game is identical: sovereign debt risks will continue to increase.”
While the Federal Reserve’s monetary policy decision will be the main event on next week’s economic calendar, markets will also receive important housing market data, regional manufacturing numbers and retail sales data.
Following the Fed’s meeting, the Bank of England will announce its monetary policy decision on Thursday, and markets are expecting the Bank Rate to remain unchanged at 3.75%.
Ahead of the weekend, the Bank of Japan’s monetary policy decision will also be on the docket. Markets are expecting a 25-basis-point increase.
Adam Turnquist, Chief Technical Strategist for LPL Financial, said in a recent note that rising interest rates in Japan could have broader implications for the global economy.
He added that investors need to watch for weakness in the U.S. dollar against the yen and a potential break below support around 152. (Kitco Global Index shows how much of today's gold move is the dollar versus the gold market itself.)
“A decisive break below this support level could accelerate the yen rally, force additional short covering, and reignite yen carry trade unwind risk, which could have ripple effects across global assets, including U.S. Treasuries,” he said.
Economic data to watch next week:
Wednesday: US Retail Sales, Federal Reserve monetary policy decision
Thursday: Bank of England monetary policy decision, US weekly jobless claims, Philly Fed manufacturing survey, US housing starts and building permits, US pending home sales, Bank of Japan monetary policy decision
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