The Fed is expected to support keeping interest rates at their current levels for a longer period.
The strong US Q1 Employment Cost Index adds to evidence of the stubborn inflation outlook.
Gold price (XAU/USD) trades close to a more than three-week low around $2,285 in Wednesday’s European session. The precious metal weakens as the US Dollar and bond yields strengthen amid firm speculation that the Federal Reserve (Fed) will opt for maintaining a restrictive interest rate environment for a longer period due to inflation remaining persistently higher than expected in the first quarter of the year.
In this context, 10-year US Treasury yields move higher to 4.69%. The US Dollar Index (DXY), which tracks the US Dollar’s value against six major currencies and is negatively correlated to the Gold price, jumps to a two-week high of around 106.50. The US Dollar remained on the backfoot last week after weak growth in Q1 Gross Domestic Product (GDP) raised concerns over the country’s economic outlook. However, it bounced back strongly on Tuesday after the US Bureau of Economic Analysis (BEA) reported strong Q1 Employment Cost Index numbers.
The US Employment Cost Index is generally driven by a strong wage growth environment in which labor demand remains strong. The index rose by 1.2% in the first quarter, against the consensus of 1.0% and the prior reading of 0.9%. It is another indication that price pressures have remained hot in the January-March period.
Gold price falls sharply, below the crucial support of $2,285, on expectations that the Federal Reserve will maintain a hawkish guidance on interest rates in its monetary policy meeting after keeping interest rates steady in the range of 5.25%-5.50% for the sixth straight time.
A slew of hotter-than-expected inflation readings so far this year indicate that the disinflation process has stalled. It suggests that the Fed should keep interest rates high for a longer period until policymakers gain confidence that price pressures will sustainably return to the desired rate of 2%.
Prospects of interest rates remaining higher bode poorly for Gold as it increases the opportunity cost of holding an investment in it. Meanwhile, investors are keen to know about rate-cut timing and the current status of the Fed’s three rate-cut projections, indicated by March’s dot plot. The CME FedWatch tool shows that traders see the Fed begin reducing interest rates from the September meeting.
In Wednesday’s session, before the Fed’s interest rate decision, ADP Employment Change and the ISM Manufacturing PMI data for April will be published in the early New York session. Economists have forecasted that fresh US private payrolls increased by 175K, slightly lower than the prior advance of 184K. The Manufacturing PMI is estimated to have dropped to 50.0 from 50.3 in March.
From the Manufacturing PMI report, investors will keenly focus on the New Orders subcomponent. The preliminary PMI survey by S&P Global for April reported that output growth cooled in line with demand weakness as new orders decreased for the first time in six months, albeit dropping only modestly. Falling new business was signalled among manufacturers and service providers alike. Upbeat employment and factory data would improve the US economic outlook, while weak numbers will deepen concerns over a slowdown.
Gold reported steep losses after a breakdown of the Bearish Flag formation in the four-hour time frame. The Bearish Flag formation demonstrates a consolidation move after a sharp correction, generally following the ongoing trend. The near-term outlook is bearish as the Gold price is trading below the 20-period Exponential Moving Average (EMA), which is at $2,312.
On the downside, March 23 high at $2,223 will be the major support for the Gold price. The 14-period Relative Strength Index (RSI) oscillates in the bearish range of 20.00-40.00, suggesting that momentum has leaned towards bears.
Gold has played a key role in human’s history as it has been widely used as a store of value and medium of exchange. Currently, apart from its shine and usage for jewelry, the precious metal is widely seen as a safe-haven asset, meaning that it is considered a good investment during turbulent times. Gold is also widely seen as a hedge against inflation and against depreciating currencies as it doesn’t rely on any specific issuer or government.
Central banks are the biggest Gold holders. In their aim to support their currencies in turbulent times, central banks tend to diversify their reserves and buy Gold to improve the perceived strength of the economy and the currency. High Gold reserves can be a source of trust for a country’s solvency. Central banks added 1,136 tonnes of Gold worth around $70 billion to their reserves in 2022, according to data from the World Gold Council. This is the highest yearly purchase since records began. Central banks from emerging economies such as China, India and Turkey are quickly increasing their Gold reserves.
Gold has an inverse correlation with the US Dollar and US Treasuries, which are both major reserve and safe-haven assets. When the Dollar depreciates, Gold tends to rise, enabling investors and central banks to diversify their assets in turbulent times. Gold is also inversely correlated with risk assets. A rally in the stock market tends to weaken Gold price, while sell-offs in riskier markets tend to favor the precious metal.
The price can move due to a wide range of factors. Geopolitical instability or fears of a deep recession can quickly make Gold price escalate due to its safe-haven status. As a yield-less asset, Gold tends to rise with lower interest rates, while higher cost of money usually weighs down on the yellow metal. Still, most moves depend on how the US Dollar (USD) behaves as the asset is priced in dollars (XAU/USD). A strong Dollar tends to keep the price of Gold controlled, whereas a weaker Dollar is likely to push Gold prices up.
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