Price of Gold Fundamental Daily Forecast – Reduction of Fed’s Balance Sheet Creates Headwinds for Investors

Gold futures are trading sharply lower on Thursday, pressured by higher Treasury yields and a firm U.S. Dollar. The catalyst behind this move is the minutes of the Federal Reserve’s December meeting that signaled officials are ready to aggressively dial back policy help.

At 10:18 GMT, February Comex gold futures are trading $1794.20, down $30.90 or -1.69%. On Thursday, the SPDR Gold Shares ETF (GLD) settled at $169.08, down $0.49 or -0.29%.

Federal Open Market Committee (FOMC) members expressed concern about inflation and said the jobs market is nearing full employment. However, the key aspect of the meeting was the extended discussion of the central bank’s balance sheet with policymakers pointing to a reduction in bond holdings in the coming months. This surprise revelation is what’s putting the most pressure on gold prices today.

Fed’s Game Changing Move – Reduction of Balance Sheet

The price action since the mid-December Fed meeting strongly suggested that gold investors weren’t too rattled by the central bank’s decision to aggressively trim stimulus and raise interest rates at least three times in 2022, but the reduction of the Fed’s balance sheet is likely to catch their attention.

According to minutes released Wednesday, Fed policymakers at their December meeting began plans to start cutting the amount of bonds it is holding, with members saying that a reduction in the balance sheet likely will start sometime after the central bank begins raising interest rates.

While officials did not make any determination about when the Fed will start rolling off the nearly $8.3 trillion in Treasurys and mortgage-backed securities it is holding, statements out of the meeting indicated that process could begin in 2022, possibly in the next several months, CNBC reported.

“Almost all participants agreed that it would likely be appropriate to initiate balance sheet runoff at some point after the first increase in the target range for the Federal Funds rate,” the meeting summary stated.

Short-Term Outlook

Thursday’s sell-off is a reaction to the headline news. Although the move is impressive, I don’t expect to see a steep plunge in prices but a gradual down trend throughout the year. This is because the Fed will need time to end tapering, raise rates and begin the process of reducing the balance sheet.

Market expectations currently are for the Fed to start raising its benchmark interest rate in March, which would mean that balance sheet reduction could start before summer.

The minutes also indicated that once the process begins, “the appropriate pace of balance sheet runoff would likely be faster that it was during the previous normalization episode” in October 2017.

Based on that last statement, we expect to see a gradual decline in gold prices throughout 2022 as the moves by the Fed are designed to remove liquidity from the markets, boost interest rates and strengthen the U.S. Dollar. All of which should make gold a less-attractive investment.