(Kitco News) After a major selloff, gold has been consolidating at the $1,700 an ounce level. And the upcoming Federal Reserve’s interest rate decision could be what gives the precious metal its new direction, according to analysts.
Gold has kicked off the second half of the year on a disappointing note, dropping nearly 6% in July as the U.S. dollar index traded near 20-year highs, with investors fleeing to the greenback for safety.
But, July’s Fed decision could be the event gold needs to make its move after touching $1,700 an ounce, said OANDA senior market analyst Edward Moya.
“This is the moment for gold that will break the precious metal’s back or offer hope that peak tightening has been priced in,” Moya said. “Investors are growing optimistic that the economic slowdown will contribute to a quicker decline with pricing pressures, which suggests the Fed’s tightening job might be done by the end of the year.”
Markets expect to see a 75 basis-point rate hike for the second meeting in a row on Wednesday, and if that is the case, gold can continue to make its way above the $1,700 level, Moya added.
However, what Powell comments on during the press conference following the meeting will be crucial. This is especially true since there won’t be any updates to the Fed’s macro forecasts and dot plots until the September meeting.
And if Powell hints that another 75-basis-point increase is possible in September, the outlook on gold could turn more negative. “The Fed won’t lock themselves into any strong stances on the trajectory of future rate hikes, but it seems they won’t be in a position to say even more aggressive rate hikes are on the table,” Moya noted.
Since markets remain highly alert to any statements about inflation and the future path of monetary policy, Powell will be careful with the words he chooses, said FXTM senior research analyst Lukman Otunuga.
“He is likely to highlight the Fed’s determination to extinguish inflation while inflicting more pain on the economy with continued policy tightening,” Otunuga said Tuesday. “There have also been worrying signs from recent data with weakness in business survey data and the jobless claims.”
According to the CME FedWatch Tool, there is still a 25% chance of a 100-basis-point rate hike in July. For September, there is a 51% chance of a 25-basis-point hike, a 41% chance of a 50-basis-point hike, and an 8% chance of a 75-basis-point hike.
One concern is the upcoming economic downturn, the timing of which is still being debated by analysts and investors. “Many parts of the economy are weakening, and that is why many are expecting the full impact of inflation to trigger a recession by the middle of next year. The risks are there for a recession later this year, but that should not be the base case,” Moya said. “Rate hikes at each meeting for the rest of the year is an easy call, but a rate hike at the May meeting still needs compelling evidence.”
The U.S. dollar has also picked up steam ahead of the Fed meeting, with the U.S. dollar index rising back above 107.
“If the Fed moves ahead with a 75-basis point hike, this may not be enough to keep dollar bulls in the driving seat. Such a move needs to be complemented by firmly hawkish comments from Powell, feeding speculation around more aggressive hikes this year,” Otunuga added. “Should the Fed surprise the market with a smaller than expected hike, this could send the dollar tumbling with a cautious-sounding Powell adding insult to injury.”
Gold has remained steady ahead of the meeting, with the August Comex gold futures last trading at $1,715.30, down 0.22% on the day. The $1,700 an ounce level remains a crucial support level to watch.
“Gold is likely to remain on standby until the Fed rate decision on Wednesday,” Otunuga noted. “It will be interesting to see how gold reacts when the Fed moves ahead with a 75-basis rate hike. Will the precious metal weaken due to its zero-yielding status? Or will a weaker dollar limit downside losses?”
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However, even a declaration of a recession is not likely to be enough to stop the Fed from tightening, said ABN AMRO’s senior economist Bill Diviney.
“While we expect a recession to be declared over the coming year, a downturn alone will not be enough to stay the Fed’s hand. Rather, ‘convincing evidence’ will be needed that inflation is coming back to target,” Diviney wrote this week. “By ‘convincing evidence’, we interpret this to mean a string of monthly (as opposed to year-over-year) core inflation readings consistent with 2% inflation – i.e. c.0.2% m/m rises.”
In its latest World Economic Outlook, the International Monterrey Fund downgraded its growth outlook for the U.S., one of the IMF’s biggest revisions. The U.S. is expected to grow 2.3%, 1.4 percentage points lower than the April forecast.
The risk of a recession would be at the highest levels in 2023, the IMF noted, citing growth bottoming out and household savings declining.
“For example, according to the latest forecasts, the United States will have real GDP growth of only 0.6 percent in the fourth quarter of 2023 on a year-over-year basis, which will make it increasingly challenging to avoid a recession,” the IMF said.
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