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Gold, Dow Future stumbled as Fed Chair Powell almost confirmed QE tapering to tightening by 2022

calendar 22/10/2021 - 19:58 UTC

Gold (XAU/USD-spot) made a 6-week high 1813.81 early Friday (U.S. session) on broader weakness in USD as USDJPY slips, and EURUSD edged up amid upbeat/mixed Japanese/Eurozone economic data. JPY and Gold were also boosted by some haven flow as U.S. President Biden almost talked about the WWW-III-like situation if China attacks Taiwan.

On Thursday, Biden was asked in a Town Hall event, Biden was asked about possible U.S. action, if China indeed attacks Taiwan and whether the U.S. would come to Taiwan's defense if China attacked? Biden answered: ”Yes. Yes, we have a commitment to do that. I don't want a Cold War with China, I just wanna make China understand - that we are not gonna step back, we are not gonna change any of our views---“

But on Friday, Taiwan tension and also Gold eased as the White House clarified there is no change to the US policy on Taiwan, commonly referred to as 'strategic ambiguity,' in an apparent effort to clarify Biden's earlier comments on defending Taiwan from Chinese attack: The President was not announcing any change in our policy and there is no change in our policy. The U.S. defense relationship with Taiwan is guided by the Taiwan Relations Act. We will uphold our commitment under the Act, we will continue to support Taiwan's self-defense, and we will continue to oppose any unilateral changes to the status quo."

The White House clarification follows a rebuke from Chinese Foreign Ministry Spokesman Wang Wenbin and an assurance from U.S. Defense Secretary Austin that ‘nobody wants to see any escalation of the China-Taiwan conflict. On Friday, Wenbin remarked that the U.S. should refrain from ‘sending wrong signals’ about Taiwan's disputed independence. Wang also stressed Beijing is not ready for concessions over what China described as its ‘core interests.

Apart from China-Taiwan-related lingering geopolitical tensions amid Chinese-US domestic political compulsion, JPY was also recovered from the deep plunge after a report that BOJ may be thinking to phase out COVID-related emergency lending tools/programs if COVID cases continue to fade. The market was expecting a 3rd extension of the emergency lending scheme, set to expire in Mar’22.

Bur the report also suggested that policymakers have not reached a consensus as discussions are preliminary, and a decision is unlikely before Dec’21, although some BOJ policymakers are discussing gradually withdrawing these emergency lending tools as with corporate funding strains easing and COVID curve flattening. BOJ/Japanese government is paying +0.1% to banks as a ‘service charge’ on such interest-free loans (actual borrowers need not pay any interest). But BOJ is also concerned that some banks may be indulged in corruption to pocket the +0.1% service charge and provide fake loans.

A BOJ source said: “Excluding some sectors, corporate funding conditions have generally improved and the need for immediate liquidity support is fading. What was intended as an emergency measure cannot last forever.”

The BOJ lending scheme lent ¥78T through last month. Japanese banks tapped ¥24.2T in a market operation in September, more than double the amount in June, but their lending has continued to slow, raising concerns they were tapping the scheme mainly to get the interesting reward rather than lend the money on to companies. But BOJ is somehow divided. There is also a political angle as new Japanese PM Kishida has vowed another big fiscal stimulus to bring out the Japanese economy from a deep COVID slumber, which was already under deflation.

Thus BOJ has no option but to continue its ‘powerful’ QQE/YCC almost perpetually even if it withdraws COVID emergency lending tools. Japan now pays almost 15% of its revenue as interest on its huge public debt and thus BOJ has to ensure the lowest borrowing costs to ‘rebuild’ the Japanese economy, the world’s 3rd largest. Japan is also the ‘financier’ of the world and now is the largest foreign creditor of the U.S. Japanese Yen and also EUR is more like a funding currency unlike USD-seen as a growth currency.

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But on Friday, Gold stumbled to a low around 1782.82 from the session high after Fed Chair Powell confirmed QE tapering to tightening by Dec’22.  

Highlights of Fed Chair Powell’ BIS conference:

·         Reiterates Fed is on track to taper asset purchases as inflation is well above target; the taper to begin soon and end by mid-2022

·         I do think it's time to taper; I don't think it's time to raise rates

·         There are still five million fewer U.S. jobs now than Feb’20 pre-COVID levels--we're still 5M jobs below high in 2020

·         High inflation will likely abate next year as pressures from the pandemic fade; still, it's not a certainty, and if inflation - already higher and lasting longer than initially expected - moves persistently upward, the Fed would certainly act

·         We think we can be patient and allow the labor market to heal

·         But it's very possible that Fed's full employment goal could be met next year, f supply-chain constraints ease as expected and the service sector opens more fully, allowing job growth to speed back up--service side of the economy is expected to return to normality as Delta variant fades

·         Our policy is well-positioned to manage a range of plausible outcomes. We need to watch, and watch carefully, and see if the economy is evolving consistent with our expectations, and adapt policy accordingly

·         I do not see consistent job losses under any liftoff that as the current situation, but I do see a growing tension between the Fed's two mandates of maximum employment and 2% price stability

·         The risks are now to longer and more persistent bottlenecks and, thus, to higher inflation. For now, the Fed needs to look through that high inflation, despite the pain, it means for households having to pay more for gas and food, to give time for the economy to work out supply kinks

·         Supply constraints and elevated inflation are likely to last longer than previously expected and well into next year, and the same is true for pressure on wages

·         But the most likely case is for inflation pressures to abate and job growth to resume its pace from this past summer

·         For now, the Fed will watch and wait

·         This is not a situation that our patient approach to the framework was designed for; I don't live in a world of certainty

·         High inflation is likely to abate but will last well into next year

·         Fed tools don't do much for supply constraints; Supply bottlenecks are still weighing

·         If we see persistent inflation we would use our tools

·         We need to make sure our policy is positioned for a range of outcomes

·         We need to consider a full range of plausible outcomes on policy

·         We need to be patient but we are watching very carefully

·         It would be premature to raise rates

·         No one should doubt that we will use these tools to guide inflation back down to 2% over time. At the same time, we think we can be patient and allow the recovery to take place, and allow the labor market to heal

·         GDP for this year will be a bit lower than we thought, especially following the impact of the Delta coronavirus variant

·         Fed’s policy intentions to equity markets have worked well so far, as Powell believes the market generally understands

·         The main focus, now, of course, is on taper - and I think the communication on that worked--the Fed strives to be as transparent as possible

·         Fed is very mindful of the effect its decision that may have implications on global financial conditions

·         At the moment, most economic risks are related to "longer" and "more persistent" supply bottlenecks, that result in high inflation

·         The interest rates should not be changed as supply constraints are directly related to the coronavirus pandemic and we don't know how long these and other issues will last

·         The inflation rate in the United States is now "well above" the 2% target

·         Fed's asset purchases are likely to end by the middle of 2022 if the economy recovers as broadly as expected

On Friday, at the BIS conference, Powell didn’t say anything new, which the market does not know. But Powell is now gradually dialing back his transitory inflation narrative and preparing the market from QE tapering to tightening as the Fed is increasingly finding itself behind the inflation curve. But Fed may not officially announce the inevitable QE tapering in Nov’21 meeting. As the October NFP job report will be available only on 5th November, two days after Fed’s 2-3rd November meeting, Powell/Fed may take another excuse to delay the QE tapering announcement to December’21 meeting with a fresh SOEP (Summary of Economic Projections-dot-plots). The Fed will now prepare the market from QE tapering to tightening (liftoff/gradual rate hikes and QT-Quantitative Tightening/Balance sheet asset/QE bond/reinvestment reductions).

Fed may watch/asses the October as well as November NFP job report and may only announce the QE tapering timeline in the Dec’21 meeting with fresh dot-plots, indicating two rate hikes in H2CY22 against the earlier one to stay ahead of the inflation curve. Price stability is now more important than maximum employment mandate for Fed to keep U.S. borrowing costs (bond yields) lower, everything being equal.

Gold is now being inversely correlated to oil as higher oil will inevitably cause more inflation, which will prompt for earlier than expected tightening by Fed, positive for USD and negative for Gold. But Gold may be supported only if there is a drastic fall in U.S. bond yields amid a sharp fall in oil, renewed uncertainty about U.S. debt limit extension after early December amid U.S. political squabbling, and if Fed temporarily refrains from any QE tapering announcement in Nov’21 meeting to postpone the same for Dec’21. Surging oil around $100 would be catastrophic for oil imported economy and the even U.S. as inflation would be out of control, leading to the next leg of economic crisis. Even a release of U.S. SPR may not help much. But Biden may go for the Iran nuke deal to bring oil down (at least psychological factor) before the 2022 mid-term election.

Bottom line:

On Friday, there was also a report that the EU may terminate the Brexit trade deal if the U.K. rift on the Irish border deepens and if the U.K. violates Article 16 of the Northern Ireland protocol. Subsequently, EUR, GBP plunged and USD jumped, while Gold slumped. Wall Street Futures (Dow, SPX and Nasdaq) also tumbled as Powell prepared the market for 2022 liftoff.

Technically, whatever may be the narrative, oil now has to sustain over 85 for the next leg of rallies towards 91-100-115 and even 150 levels; positional/weekly support around 77.00 level; only consecutive closing below 77.00, the oil may fall to 63 zones.

Technically, Gold now has to sustain over 1815 levels for a further rally towards the 1835 area; otherwise, it will fall to 1800-1760-1743-1718-1695-1675/1665 levels in the coming days. If oil surged above $100 and Gold broke below $1665, then Gold may further fall to $1450-1250 levels also.


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