Gold (XAU/USD-spot) made a 7-weeks low around 1721.25 last Wednesday (29th September) on broader strength in USD amid policy divergence between Fed and ECB, European energy crisis, and higher US bond yields as Fed is going for complete QE tapering by June-Sep’22 followed by liftoff by Dec’22 to control uncontrolled inflation. But Gold also bounced back from 1721 levels last week to almost 1771 Monday (4th October) on renewed debt default concern of both China’s Evergrenade and U.S. Treasury coupled with apparently less dovish rhetoric by USTR over China trade issues.
Gold was boosted on the concern of U.S. rating downgrade amid lingering political saga over debt limit hike or suspension. And Gold surged as contrary to earlier expectations, there was a news headline, suggesting Biden admin may not go for any pro-active steps for U.S.-China trade truce and may also continue Trump tariffs in present form.
But Gold again slips from 1771 area as fine prints of USTR statement on China trade policy shows less hawkish stance contrary to earlier news headlines. And the U.S. debt limit will be eventually raised or suspended by the next few days/weeks
Biden is now trying to compete with China by investment-led economic growth. Biden is trying to sell his Build Back Better plan (human infra for $3.5T as well as infra stimulus plans for $1.2T so that America will be able to compete with China on an equal footing. Biden is crying foul of China’s economic growth and prosperity because of China’s state-sponsored public capitalism model in an autocracy against America’s private capitalism in a democracy. But after all, Biden admin makes it quite clear that U.S. will not escalate the Trump trade war strategy, will engage with China for a better relationship, keeping in mind U.S. interest. Biden admin may also exempt more consumer goods from China from Trump tariff exclusion.
On Tuesday, roared back and Gold slips as contrary to earlier market news headlines, the fine print of USTR statement reveals Biden admin less hawkish on China than Trump admin. As per reports, U.S. and China will hold a meeting between top officials this week in Switzerland that will include negotiations about a possible virtual summit between President Biden and Xi Jinping, his Chinese counterpart. The U.S. NSA Sullivan will meet Jiechi, China’s top foreign policy official, on Wednesday.
In his 2nd official conversation with Xi since he took office, Biden reportedly suggested that they hold an in-person summit, but Xi did not respond and urged Biden to tone down America’s anti-China rhetoric. The Biden admin is also preparing to hold trade talks with China for the first time. On Monday, the USTR Tai said she would soon hold direct talks with Liu He, her Chinese counterpart.
U.S. Core PCE inflation trend shows Fed may go or two rate hikes in H-2022 instead of one to stay ahead of the curve-negative for Gold:
On Friday, the U.S. BEA data shows that core PCE inflation increases +0.32% in August vs +0.34% in July sequentially (m/m), above market expectations of +0.20%. On a yearly (y/y) basis, the U.S. core PCE inflation jumped +3.62% in August, unchanged from July. Overall, in CY21, the U.S. core PCE inflation is increasing around +0.37% sequentially on an average; i.e. the annualized rate at +4.83% against the Fed’s projection of annual rate +3.70%.
Assuming, Fed will consider average core PCE inflation between CY18-23 (6-years) at around +2.00% for its average inflation targeting mechanism, the actual average inflation for CY:18-20 was around +1.39% (below Fed’s target +2.00%) and Fed projected average inflation for CY:21-23 around +2.73% (much above target +2.00%). Thus as per Fed’s latest Sep’21 projections and actual inflation for CY:18-20, the average inflation would be around +2.00% over CY:18-23 (6-years).
Although Fed has not specified the timeline of look-back period for the average inflation framework, Fed said it will allow inflation to run “moderately” over +2.00% for “some time” to adjust for lower than targeted inflation in the previous years, so that overall inflation for the period remains around +2.00% on an average. Although, Fed has not defined the term ‘moderate’ and ‘some time’, Fed/ Chair Powell has already acknowledged inflation already achieved substantial further progress towards its average inflation goal +2.00% (from Dec’20 levels) for the QE tapering purpose. The same is also almost done for the maximum employment mandate.
Now the question is the timeline of liftoff after Fed is expected to complete the QE tapering by June-Sep’21. Fed already indicated liftoff by late 2022 amid surging inflation and good progress of employment. If core PCE inflation continues to run well above +0.30% sequentially; i.e. above an annualized pace, +3.60%, then-Fed has no option but to go for tightening more quickly and may hike twice in 2022, to stay ahead of the inflation curve/target (average inflation +2.00%). Elevated commodity/energy inflation coupled with supply bottlenecks and labour shortage may complicate Fed’s balancing act to stay lower for longer to support U.S. employment and borrowing costs going forward. Also, Bidenflation and internal political/policy squabbling within Democrats are causing policy uncertainty for Fed also.
On Monday, the St. Louis Fed President Bullard, an influential Policymaker said U.S. producers now have a rare pricing power, which may fuel more rapid inflation in the coming days. Bullard also argued for complete QE tapering by June’22 and two rate hikes in 2022 against market expectations of one rate hike.
Fed may go for two rate hikes in 2022 instead of one to stay ahead of the inflation curve. Fed has to tighten more aggressively to limit excessively high demand and inflation spiral. Fed has to ensure the Goldilocks nature of the U.S. economy as inflation expectations are going parabolic. Thus Fed is now sounding more hawkish than expected, which is positive for USD and negative for Gold. The yellow metal also now has less appeal as a traditional hedge against rising inflation as equities and cryptos are providing much higher real yield.
Technically, whatever may be the narrative, Gold now has to sustain over 1773/78-86 for a further rebound; otherwise, 1705-1667 may be on the card.