Gold struggles for bottom as Fed tightening outlook debated

Gold market participants are scrambling for some breathing room after the selloff that has mired the market since March, when it broke above the $2,000/oz level. Gold fell 2% last week, marking its fifth consecutive decline, its biggest streak of weekly losses since 2018, when it fell for six straight weeks.

Gold has fallen to consecutive lows, reflecting a buildup of bearish sentiment and the main reason for this is the strength of the US Dollar. The 5-day moving correlation between gold and the US dollar index is close to -0.8 against an average of around -0.2 this year.

The US dollar has been the benchmark asset in recent weeks and tested new highs from 2002 amid growing concerns about the health of the global economy and expectations that the Fed could lead other banks central to monetary tightening.

The US currency received another boost this week as US inflation data bolstered market expectations for aggressive action from the Fed. U.S. consumer prices rose 9.1% on the year in June, the fastest pace in 40 years, beating market expectations of 8.8% growth. U.S. producer prices also saw stronger-than-expected growth of 11.3% last month.

The Fed began raising interest rates in March and accelerated the pace of rate hikes from 0.25% in March to 0.5% in May and 0.75% in June. With inflation showing no signs of abating, market participants priced in the possibility of an even bigger and unprecedented rate hike of 1% at the next meeting. This led to a massive sell-off in commodities, including gold. While gold fell to an 11-month low, copper slipped to its November 2020 low and crude oil reversed most of the gains recorded since the start of the Russian-Ukrainian war.

The U.S. dollar lost some momentum at the weekend as comments from Fed officials calmed market nerves about a bigger rate hike at the next meeting, which helped the to stagnate near the $1700/oz level. A strong US retail sales reading and a marginal decline in inflation expectations also helped the US currency off the highs.

Gold is further under pressure from concerns over consumer demand in China and India. Chinese economic activity remains mired by virus-related restrictions and no respite is expected unless the spread of the virus is brought under control. China’s GDP grew 0.4% year on year in the second quarter, much slower than market expectations of 1% growth, highlighting the stress in the economy. Indian consumer demand could also be affected as prices remain stuck near Rs 50,000 amid a weaker rupee and the government’s decision to raise import duties. The Indian rupee fell to a historic low against the US dollar.

Gold is currently viewed more as a commodity than a safe-haven asset or inflation hedge. Given this trend and the focus on central banks, the US dollar may remain the main price driver and gold may not rally unless we see a sustained decline in the US currency. We may not see much respite until the next Fed meeting, however, the US Dollar has seen a relentless rise and may be challenged by monetary tightening measures from other central banks.

Ahead of the Fed’s next meeting on July 26-27, the focus will be on monetary policy decisions from the European Central Bank and the Bank of Japan over the coming week.

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