Gold Sees Light at The End of The Fed’s Tightening Tunnel

The comments below are an edited and abridged synopsis of an article by Arkadiusz Sieroń

The Fed has lifted interest rates from very accommodating to moderately accommodating levels. There is still a lot of room before reaching restrictive levels. This is not good for gold, which generally doesn’t like rising interest rates.

Gold Sees Light at The End of The Fed’s Tightening Tunnel - BullionBuzz - Nick's Top Six
Golden light comes from the built stone cave

The signs are, however, that the Fed will soon ease its stance. Additionally, it got rid of its forward guidance. The Fed could have provided a decisive hawkish path of rate hikes; instead, it will be data dependent. This suggests that the Fed is worried about the recession and is preparing a justification for a dovish turn.

The US economy has already entered a technical recession. According to the Bureau of Economic Analysis, GDP dropped 0.9% in Q2, following a 1.6% contraction in Q1. Also, the full effect of interest rate hikes hasn’t been felt by the economy yet and the odds of a soft landing have decreased.

The Fed is comfortable with tightening monetary policy while unemployment is low. However, the labour market is in worse condition than the unemployment rate suggests, and it is a lagging indicator. Thus, if economic news worsens, especially in relation to the labour market, the Fed may return to an accommodative stance.

It could be difficult for the heavily indebted and financially fragile economy to take higher interest rates. The Fed could raise the federal funds rate three more times by 50 basis points at best, reaching its predicted level for 2023. Given that the economy has already weakened significantly, the Fed may stop tightening earlier. It will be hard to justify interest rate cuts with high inflation, but if it peaks and there is disinflation, the Fed could pause hikes and adopt a more dovish stance.

The US economy will slow, but that doesn’t mean the Fed will bring inflation under control. Rather, there could be stagflation, which should be positive for gold. The July FOMC meeting was the first one in months that wasn’t hawkish, mainly because of the economic slowdown (recession). The deteriorating macroeconomic outlook should boost safe-haven demand for gold, while a steep pace of hikes (that will slow down soon) could see gold begin its next rally.

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