Gold Rally Reverses, Sinking With Risk Assets on Fed Hike Fears

By Barani Krishnan

AiVIF.com -- The safe-haven rally in gold wasn’t “safe” beyond the weekend.

The yellow metal’s run-up to five-week highs on Friday was abruptly reversed on Monday amid risk aversion across markets on the eve of the third anticipated Federal Reserve rate hike for this year.

Front-month gold futures for August on New York’s Comex settled down $43.70, or 2.3%, at $1,831.80 an ounce. It was the sharpest one-day drop in Comex gold since May 2, when it lost 2.5%.

Gold’s rundown coincided with the runup in the dollar, which neared a fresh two-decade high of 104.96 against a basket of six major currencies.

Adding to the pressure on the yellow metal was a rally in benchmark U.S. bond yields, where the return on the 10-year Treasury note hit an 11-year peak of 3.348%.

Other risk flight casualties included Bitcoin, which fell 18% to below $23,000, plumbing its lowest since December 2020. Wall Street entered bear-market territory, with the S&P 500 losing more than 20% on the year and Nasdaq Composite dropping over 30% for 2022 so far.

The only “safe” risk, if any, appeared to be oil, with crude prices returning to the positive by lunch hour in New York, after spending the morning in the red.

“The driver of all of this negativity in the markets centers around high inflation and higher yields which have been bad news for gold this year,” said Craig Erlam, analyst at online trading platform OANDA.

The Labor Department reported on Friday that the Consumer Price Index , or CPI, grew by 8.6% in the year to May, expanding by its fastest rate since 1981, as the cost of virtually everything - from food to fuel, shelter and clothing - spiked last month.

The inflation data came just ahead of Wednesday’s policy meeting of the Fed. After leaving rates at between zero and 0.25% for a period of two years due to the coronavirus outbreak, the Fed’s Federal Open Market Committee, or FOMC, raised them in March by 25 basis points, or a quarter-percentage point, and in May by 50 basis points, or a half-percentage point.

The June meeting of the FOMC was initially expected to result in another half-point rise. But after the red-hot CPI number for May, some economists are speculating that the central bank might be toying with a 75 basis point, or three-quarter percentage point, hike instead.

Erlam acknowledged that thinking on Monday, saying “a 75-basis point hike is being increasingly priced in, although the base case is still 50 basis points.”

He added that while gold was “still a safe haven in many circumstances, a higher dollar and yields are a big negative for the yellow metal and a break of that support may now be on the cards ahead of the Fed meeting on Wednesday.”

Gold is supposed to be a hedge against inflation and it typically rallies when investors become worried about a reduction in the purchasing power of the dollar. But it’s not a perfect correlation as gold has also broken down various times this year when inflation data came in higher.

Further confounding the hedging theory, gold and the dollar have also rallied together on various occasions this year as inflation concerns propped up bullion prices while the greenback rose on expectations of Fed rate hikes. That was the situation on Friday when August gold on Comex rallied to a five-week high just shy of $1,880 even as the dollar and Treasuries jumped.