Gold futures are edging lower on Friday, pressured by a rise in Treasury yields and a stronger U.S. Dollar. The choppy price action is begin fueled by nervousness over an upcoming Federal Reserve policy meeting on November 2-3 that is expected to offer further guidance on tapering as inflation expectations rise.
At 12:08 GMT, December Comex gold futures are trading $1789.50, down $13.10 or -0.73%.
High Inflation Expectations versus Prospect of Rate Hikes
Gold has been trending higher since the last Federal Reserve meeting on September 29. It has rallied from $1721.10 to $1815.50. The primary catalyst behind the move has been high inflation expectations.
Additionally, since the Fed’s September 29 meeting, U.S. 10-year yields have risen more than 20 basis points, hitting a five-month high of 1.7% earlier this month. This move was driven by the Fed’s comments following the meeting. It said it would likely begin reducing its monthly bond purchases in November and hinted that interest rate hikes may follow.
Over the long-run, this relationship won’t last. If interest rates are moving higher then gold prices are going to have to come down. Based on this assessment, I think we’ve reached the line in the sand where gold investors will be forced to make a major decision. The actual price of this proverbial line in the sand is $1795.00. Trader reaction to this level should dictate the direction of gold prices over the near-term and perhaps over the long-run. It all depends on how aggressive the Fed is with interest rates.
Some Investors Betting on Aggressive Moves by the Fed
Investors in U.S. interest rate options are paying for trades that benefit from a much earlier-than-expected monetary tightening by the Federal Reserve to fight off stubbornly high inflation, including multiple hikes from next year until 2023, Reuters reported.
The one-year forward rate on U.S. two-year swaps, that part of the curve most sensitive to rate hike expectations, on Thursday was implying a rate of 1.27% by October 2022, compared with the spot rate of 0.639%.
That forward rate suggests a more than 60 basis-point sell-off in U.S. 2-year swaps that pushes their rates higher, an ambitious outlook that suggested two rate hikes next year have been factored in, consistent with market expectations, analysts said.
“The sell-off in the front end is priced in very mechanically with the Fed,” said Bruno Braizinha, senior rates strategist, at BofA Securities in New York. “What the (swap rate) sell-off implies is a series of hikes that are getting front-loaded.”
Additionally, futures on the Fed Funds rate, which track short-term rate expectations, have fully priced in a quarter-point tightening by July 2022, factoring in another rate increase by December.
Short-Term Outlook
Some bullish gold traders blame the lack of clarity from the Fed in handling the rise in inflation as one reason for the sharp rise in prices since September 29. This has created a mismatch between gold trader expectations for inflation and bond trader expectations for rate hikes. Well something has to give and the catalysts are likely to come from the next Fed monetary policy statement.