Will Gold Survive Another Jumbo Rate Hike?

Written by: Arkadiusz Sieron, PhD

The key FOMC meeting ends soon. One thing is certain: after this event, the gold market won’t be the same.

The Fed’s Projection Will Be Key for Gold

Ladies and gentlemen, please take your seat and fasten your seat belt, as we’re approaching the FOMC meeting and there could be some turbulence! Actually, gold has already entered an area of turbulence and has declined below the psychologically important level of $1,700. As the chart below shows, the price of the yellow metal has declined from $1,726 last week to the current level of $1,664, in a response to the strengthened expectations of a more hawkish Fed.

The sad truth is that if today’s FOMC meeting turns out to be more hawkish than expected, gold may go down even further. On the other hand, if the Fed surprises markets with a dovish side and provides some clues about the end of its tightening cycle, gold may catch its breath and even rebound somewhat.

What can we expect? Well, some analysts say that the Fed could deliver a full percentage point hike in the federal funds rate to show markets that it’s taking inflation seriously. Such a decision could ruin gold. However, I doubt it. Such a big raise could be interpreted as a panic move and be counter-effective. This is why I expect another 75-basis point hike. This is also supported by futures: the odds of such a move are 84%, while the chances of a full 1% move are only 16%, according to the CME FedWatch Tool. The size of the hike is one thing. However, the markets also await for fresh economic projections, as investors want to know how high the Fed will raise interest rates and what the economic effects of these hikes will be. What can we expect here? Well, long story short, prepare for projections of slower GDP growth, higher inflation, a higher unemployment rate, and higher interest rates. The interest rate forecast for the next year could move from the current 3.8% to 4-4.5%. If the new dot-plot turns out to be more aggressive, gold could get another hit.

On the other hand, Powell and his colleagues are likely to put numbers to the “pain” they’ve been thinking of in recent days. Hence, the expected unemployment rate will rise to reflect the effects of rising interest rates on aggregate demand. The economic slowdown and deteriorating labor market, in the Fed’s eyes, could provide some support for gold prices, especially if their scale is larger than expected.

Implications for Gold

How does the FOMC meeting affect the gold market? Well, it depends, but given the persistent inflation, the monetary policy statement and Powell’s press conference would be decisively hawkish. The federal funds rate is likely to rise by another 75 basis points, the next jumbo-hike in a row, and its forecast for the next year will also increase, creating downward pressure on gold prices. True, much of this is already priced in, so the mere absence of a full 1% increase could provide relief for gold. However, I’m afraid that the event could catalyze the next leg lower in precious metals, especially if we get any hawkish surprises.

Gold bulls will seek clues about the much-anticipated Fed’s pivot. I don’t expect any such hints at this meeting, but there might be signals about the slowdown in the pace of interest rate hikes. There is a clear limit to how high the Fed is willing to hike rates, especially given that the higher the rates, the more costly the federal debt is and the greater the odds of a recession. And the higher we climb, the closer we are to the peak. Gold could find some comfort there. If not comfort, then the bottom at least, setting a stage for the rally in the future.

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Related: After a July Slowdown, Has Inflation Finally Peaked?