Abstract: Dollar bulls rallied after hawkish comments from the Federal Reserve, sending gold sharply lower. While U.S. economic data continued to improve, the labor market moved at a very slow pace, prompting speculation that the Federal Reserve may struggle to taper its quantitative easing. At the same time, a sharp fall in long-term Treasury yields helped support a rally in the non-interest bearing asset gold. Consequently, the gold market may fall into sharp volatility due to the uncertainty about the Federal Reserve's monetary policy actions.
The price of gold fell sharply to $1,750.75 an ounce, its lowest level since mid-April, as fears of tapering quantitative easing (QE) spread amid hawkish signals from the Federal Reserve (Fed). However, the U.S. non-farm data for June reversed gold's weakness. The metal edged higher from its lows after the jobs report showed a sharp 850,000 jump in payrolls but a rise in the unemployment rate to 5.9%, raising expectations that the slow recovery in the labor market was unlikely to trigger a rush by the Fed to tighten its QE policy and start a hike interest rate. But bullion could come under pressure as a prominent U.S. economic recovery and the Fed's willingness to taper QE will lift the dollar out of its gloom at a time when much of the world is stuck with COVID-19, while rising global inflation pushed gold higher at the moment. Furthermore, the divergent views among Fed officials on whether to maintain QE may make the gold market more volatile. So how should investors prepare for the coming market turmoil? What are the factors underlying the trend of gold?
Gold ETFs had boosted their holdings of the precious metal, driven sharply higher by the weakness of the dollar. As the greenback rallied strongly in June, gold prices suffered a huge setback and institutional investors withdrew from the market, as shown below:
Source from: World Gold Council
Still, as fears about global inflation continued to mount, central banks were building up their gold reserves. According to Bloomberg, the Bank of England's London reserves, one of the largest store of gold anywhere in the world, has been selling gold at an unusually high premium that may have been driven by the Bank for International Settlements, which trades gold on behalf of central banks around the world. It also suggested that central banks have returned to the gold market after selling off the metal in the third quarter of last year when prices soared. Central banks of Serbia, Thailand and Ghana were all interested in adding to their gold holdings. And about a fifth of central banks planned to increase their gold reserves in the coming year, according to a survey published last month by the World Gold Council. As a result, many in the market see central bank purchases of gold as a way to restore some of the gold's shine. However, it is worth noting that the Fed may have to taper its QE policy in the short to medium term as inflation pressures are rising, which is likely to bring downside risks to gold. What are Fed officials' view of the inflation and monetary policy?
At its June monetary policy meeting, the Fed kept short-term interest rates near zero and kept the pace of asset purchases on hold for some time. While Fed Chair Jerome Powell said the central bank would begin to discuss when and how to unwind its QE policy, regional Fed presidents were strikingly different in their views on QE tightening. Among the Fed officials with explicitly hawkish views:
- Dallas Fed President Robert Kaplan wanted to taper asset purchases "soon" and said a monetary policy change had already been noticed to approach, but the thing was when it would come.
- James Bullard, president of the St. Louis Fed, said inflation was likely to remain above the Fed's 2% target and expected the first rate hike in 2022.
- Boston Fed President Eric Rosengren noted that Fed officials should consider a double-speed tapering program, where scaling back purchases of mortgage bonds would start much earlier than the tapering of Treasury bonds purchase.
- Philadelphia Fed President Patrick Harker wanted to start scaling back the Fed's asset-buying program this year, saying he is " in the camp of starting the tapering process".
In contrast, Fed officials elsewhere maintained a dovish tone. The lastest Fed minutes showed that officials weren't ready to communicate a schedule for scaling back their bond-buying program, due to high uncertainty in economic recovery process. However, if the U.S. continues to report positive economic and employment data, then Fed officials' hawkish stance on tightening QE could send gold into turmoil.
Gold fell by 7.2% in June, its worst monthly performance since 2016, as a strong economic recovery and hints from Fed officials that they would pursue relatively prudent monetary policy to combat the threat of higher inflation reversed the dollar's long-term weakness. But the metal rose above $1800 an ounce and briefly settled at $1,815 an ounce, its highest level in nearly two weeks, on the back of a sharp drop in Treasury yields following the release of the U.S. jobs data and the latest services PMI, as shown below:
Source from: Mitrade
Based on technical analysis, gold bulls strongly rallied and managed to break through the nearly-one-week sideways channel and the 100-day moving average, as aggressive buying increased after gold hit the oversold levels. On top of that, the MACD indicator showed that the MACD was attempting to move above the signal line and appeared to form a 'golden cross', which could send a positive bullish signal. If gold bulls continue to rally in the short term, investors should watch for the $1830 resistance level.
All told, while the recovery in major economies is picking up pace, the expected slower-than-expected recovery in the U.S. labor market could prevent the Fed from taking aggressive action. And the Fed's QE policy could change at any time if more strong economic data is released, which could send the gold market into wild swings. Investors should therefore carefully watch the Fed's views on the outlook for the economy and inflation, while taking advantage of the volatility triggered by the uncertainty of Fed's policy.