(Kitco News) - The gold market continues to see solid selling as U.S. bond yields push to their highest levels in nearly two decades, driven in part by expectations that persistent inflation pressures are forcing the Federal Reserve to raise interest rates.
However, one international bank suggests that despite the selling pressure, the gold market remains fairly resilient and is attracting some underlying support.
“Markets are now pricing in roughly a 90% probability of a Federal Reserve rate hike this week. Moreover, the renewed tensions in the Middle East have pushed up oil prices and, consequently, interest rate expectations more broadly, not just in the United States. Against this backdrop, it is somewhat surprising that gold prices have not come under more significant pressure so far,” said Thu Lan Nguyen, Head of Commodity Research at Commerzbank, in her latest research note.
Spot gold last traded at $4,295 an ounce, neary unchanged on the day.
Nguyen said that gold’s relative strength could reflect markets hedging against an impending collision between the Federal Reserve and the Trump administration.
Since his election win nearly two years ago, President Donald Trump has aggressively lobbied the Federal Reserve to lower interest rates to support the economy. He has also initiated Department of Justice investigations in an attempt to remove members of the monetary policy committee.
Nguyen noted that at the start of the year, it looked like the Federal Reserve was set to aggressively lower interest rates, with markets pricing in two rate cuts this year. However, expectations shifted dramatically after the U.S. and Israel went to war with Iran, causing significant disruptions to the global energy supply and pushing inflation pressures higher.
“Faced with persistently elevated inflation, the Federal Reserve is increasingly under pressure to raise interest rates, while President Trump has threatened extreme measures should the Fed fail to cut rates. As a result, a confrontation appears almost inevitable, and financial markets seem to be increasingly taking this risk into account,” she said. “We have long warned that the independence of the Federal Reserve could come under threat from intense political pressure emanating from the White House. However, the central bank's dilemma would only become apparent once its policy mandate became incompatible with the wishes of the US administration, or more precisely, the US President.”
Nguyen speculated that this is one reason why the U.S. dollar has remained under pressure, even as bond yields have pushed to their highest levels since before the 2008 Great Financial Crisis. She added that the U.S. dollar risk premium is also rising in the options market.
“After hedging costs against a depreciation of the US dollar against the euro had normalised during the first quarter of this year, becoming noticeably cheaper, they have recently begun to rise again significantly,” she said.
Although higher interest rates weigh on gold by raising the precious metal’s opportunity costs as a non-yielding asset, the German bank sees limited downside for gold through year-end.
In July, Commerzbank downgraded its gold forecast and said it expects prices to end the year around $4,500 an ounce, down from its revised June forecast of $4,800.
Nguyen also noted that the bank's long-term bullish outlook remains intact because the structural drivers that fueled gold's rally earlier this year have not disappeared. She noted that growing skepticism toward the U.S. dollar as a traditional safe-haven asset, driven by unpredictable U.S. policy, continues to support demand for bullion. (Kitco Global Index shows how much of today's gold move is the dollar versus the gold market itself.)
At the same time, Commerzbank explained that mounting government debt across advanced economies has raised concerns about the long-term safety of sovereign bonds, further enhancing gold's appeal as an asset that is institutionally independent and carries no default risk.
