Fed expected to fight inflation at all costs

Worsening inflation has prompted Fed officials to move around sharply raising interest rates, the minutes of the Fed's June policy meeting released overnight showed. Interest rate hikes are good for the U.S. dollar and U.S. bond yields, increasing the opportunity cost of holding gold, a non-yielding asset. The traditional divide between Fed “hawks” and “doves” has been closed, and they have agreed to raise interest rates high enough to bring inflation back to the Fed’s 2 percent target, and public approval is required.

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U.S. job vacancies fell less than expected in May, suggesting the labor market remains tight, which could keep the Fed on an aggressive monetary policy path as it tackles high inflation. A survey released by the Institute for Supply Management (ISM) showed that while employment in the services sector contracted for the third time in the past five months in June, companies raised their competency requirements for job seekers, complaining of "the inability to find qualified applicants to fill positions"

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Investors believe the Fed is likely to continue raising interest rates more aggressively than many other global central banks as the U.S. faces its worst inflation in decades, and a strong dollar could help the Fed fight inflation by lowering the prices of imported goods. In fact, the central banks of developed economies such as the euro area, the United Kingdom and Japan have either not raised interest rates or have failed to keep up with the Fed's aggressive rate hikes, and their currencies have depreciated by double digits against the US dollar during the year. Especially in the euro zone, where gas prices have soared, the euro fell to a near 20-year low of 1.0160 against the dollar, close to parity with the dollar.

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The minutes of the Federal Reserve meeting showed that the FOMC may continue to raise interest rates for a longer period of time to curb inflation expectations. Gold has lost nearly 4% in the past two days, losing out to the U.S. dollar among safe-haven funds as recession fears mount. Gold-backed ETF holdings have fallen by 39 tonnes in the past six sessions to their lowest level in nearly four months.

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The U.S. dollar's attractiveness as a safe-haven asset surpasses that of gold, and rising U.S. 10-year real yields are weighing on gold. Gold prices are likely to stay below $1,800 for the foreseeable future. Buying the dip is effectively trying to grab a knife from the sky as gold's decline accelerates. Unless the dollar tops out, $1,721 and $1,700 are potential support levels for gold bulls to consider closing out stops.

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World Gold Council: We think a rate hike could have a negative impact on gold, but many of these hawkish policy expectations have been priced in. At the same time, persistent inflation and geopolitical risks are likely to maintain safe-haven demand for gold. In a potentially stagflationary environment, the underperformance of stocks and bonds could also be bullish for gold.

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Investors face a challenging environment in the second half of 2022, dealing with rising interest rates, high inflation and the re-emergence of geopolitical risks. In the near term, gold will likely remain responsive to real interest rates, which are driven by the pace at which central banks around the world are tightening monetary policy to control inflation.

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In June this year, global gold ETFs saw a 28-ton ($1.7 billion) reduction. It was the second consecutive month of reductions following a 53-ton ($3.1 billion) outflow in May. While the recent cuts were enough to drive a net outflow of 39 tonnes ($2 billion) from ETF holdings in the second quarter, the year-to-date net gain remains at 234 tonnes ($14.8 billion). Total gold ETF holdings stood at 3,792 tonnes ($221.7 billion) at the end of June, up 6% so far this year.

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According to CME's FedWatch tool, traders in federal funds rate futures are forecasting a 75-basis-point rate hike from around 83 percent to more than 90 percent in July. Gold's decline became apparent as the US dollar index continued to remain firm as the minutes of the FOMC meeting released on Wednesday injected fresh blood into the US dollar index.