The combination of surging inflation, recently hitting 6.8%, the highest since the 1980’s, and both FOMC members having been read the riot act by the White House, has driven a clear change in focus at the Fed from job creation to combatting inflation. The encouragement from the White House being driven by Biden’s slump in the polls as millions of Americans are getting hurt by rapid rising prices of everything from fuel to food and housing.
There is no doubt the FOMC will deliver a hawkish outcome tonight, but how the market will react is not straight forward. In his latest update titled “The Fed expectations conundrum”, our Head of FX Strategy, John Hardy discussed three potential scenarios, and how the market may react to each of them.
Being the most interest rate and dollar sensitive of all commodities, gold may see a strong reaction to the outcome, and given the price behavior in the run up to the announcement, traders have moved to the side of caution. Driven by worries that the FOMC may opt for what John Hardy calls the hawkish case, where the Fed delivers a doubling of the speed of tapering by $30 billion or faster. Doing that would leave the door wide open for the Fed to move forward the lift-off date to March from current expectations for June.
Ultimately gold’s direction will, as mentioned, be determined by the response in long-end yields and the dollar. The outlook for 2022 remains clouded with most of the bearish gold forecasts being driven by expectations for sharply higher real yields. Real yields have throughout the past few years shown a high degree of inverse correlation with gold, and it’s the risk of a hawkish Fed driving yields higher that currently worries the market.