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Gold (XAU/USD-spot) made a two-month high around 1842.71 early Wednesday (US session) on increasing geopolitical tensions between Russia-U.S. over Ukraine. US / global bond yield eased and Gold surged amid safe-haven flow on the concern of an imminent conflict between Russia and Ukraine; equities slumped amid risk-off sentiment. White House Press Secretary Psaki said Tuesday that Russia could launch an attack on Ukraine at any point, possibly between January and February.
Gold was gyrating in a narrow range 1830-1800 for the last few days, almost flat on renewed appeal of safe-haven assets despite surging US bond yield. The US10Y bond yield soared to +1.897% early Wednesday, the highest since Jan’20 amid the concern of elevated inflation and faster Fed tightening. There is speculation that Fed may have to hike +0.50% in March to restore inflation credibility, even if that may cause mayhem in Wall Street.
But US10Y bond yield eased to +1.829% mid-Wednesday amid haven flows (safety of sovereign bonds) on increasing geopolitical tension over Russia-Ukraine issues. The foreign ministers of Germany, the United Kingdom, the United States, and France will meet on 20th January, while the U.S. House panel is to get a classified briefing on Ukraine. An EU diplomat said: “Europe is now closer to war than it has been since the breakup of former Yugoslavia."
Primarily, Russia/Putin is suffering from an insecurity issue and wants NATO to ban Ukraine and other former Soviet states from ever becoming members of the organization. Russia does not want to encircle itself with several NATO members. Thus Russia is using Ukraine and gas (for Europe) as leverage against U.S./NATO. But NATO refused any such assurance and many summits held over the last few weeks, between Russia and NATO/U.S. have failed to resolve the security issue. If the U.S. goes for harsh sanctions like Iran for Russia, then it will affect trade (including gas supply) for Europe.
As a recapitulation, back in 2014, Russia accused Kyiv of abuses and its forces seized control of Ukraine's southern peninsula of Crimea. The territory has a Russian-speaking majority. It then voted to join Russia in a referendum that Ukraine and the West consider illegal. U.S./NATO maybe apprehend the same pattern of Russian action this time. And there are complex geo-political issues too. The popularity of both U.S. President Biden and U.K. PM Johnson is declining fast back home over economy, inflation and lockdown party (Johnson) issues. Thus both Biden and Johnson are eager to score on the Russia-Ukraine issue to boost their approval rate back home ahead of elections.
On the other side, Putin sees present COVID disruption and political instability in the U.S. (weak President-Biden) as a major opportunity to settle on the long-pending NATO issues. Putin insists if NATO accepts memberships of some erstwhile Soviet Union neighbors, then it will establish a similar military base in neighboring South American countries of the U.S.
On Wednesday, Ukrainian President Zelensky said he held a phone call with NATO Secretary General Stoltenberg and discussed the possibility of his country taking part in the alliance's summit in June. Zelensky tweeted: "Had a phone conversation with @jensstoltenberg. Exchanged information and views on the diplomatic efforts needed for stability in Europe. Discussed preparations for the NATO Summit in June and Ukraine's possible participation in it. The open-door policy remains unchanged!” The conversation comes after U.S. Secretary of State Blinken met with Zelensky during his visit to Europe to discuss ongoing tensions with Russia and Kyiv's and the West's fears Moscow may launch an attack on Ukraine.
On Wednesday, the Russian embassy in Washington has issued a statement advising the U.S. to abandon its plans of supplying Ukraine with more weapons, adding that Moscow has no plans to start an armed conflict: "We stress once again: Russia is not going to attack anyone. The practice of moving troops on our own soil is a sovereign right. We call to end the hysteria and not to pile on tension around the Donbas problem. And most importantly - not to push ‘hotheads’ in Kyiv towards new provocations”. The Russian embassy's comments come after the White House voiced concerns about Russia may invade Ukraine from the territory of Belarus being that the two neighboring nations announced their intent to hold joint military drills.
Gold is getting a boost on renewed appeal of a safe-haven asset amid increasing geopolitical tensions over Russia-Ukraine/U.S./NATO. The market is concerned about a mini WW-III as an all-out war between Russia-Ukraine/NATO may also involve China and Iran. As a pointer, there was WW-II after 10-years of 1917-20 Spanish Flu pandemic. But the question is whether such bizarre WW-III will ever happen? The most probable answer is simply ‘no’.
America, Russia, China, the U.K., France and Israel are the biggest producers/exporters of weapons and thus these countries create an atmosphere, that ‘force’ some arms consumers/customers to buy weapons to defend themselves. For example, U.S., France and U.K. are now exporting weapons to Ukraine to ‘defend’ the nation from Russian aggression. Japan is buying U.S. weapons to defend itself from North Korean missiles. China is helping both Russia and U.S. to sell weapons to India and the list goes on.
Gold is also a safe-haven asset and a traditional hedge against inflation as well as a great beneficiary of consistently high public debt, deficit, and devaluation of paper currency. On the other hand, Gold has theoretically no yield like bonds and thus higher bond yield is normally negative for Gold. Also, higher USD is negative for Gold (in USD terms). Thus the movement of Gold is dependent on a confluence of some contradictory factors, limiting the overall volatility.
But eventually, the mid-term outlook of Gold will be dependent on Fed’s policy action. Fed is actively preparing the market for faster tightening to control uncontrolled inflation. Fed Chair Powell is now under huge pressure from Biden & Co to control runaway inflation by immediate tightening so that inflation can be brought under control before Nov’22 mid-term election; otherwise, Biden may lose both Senate and House as common Americans are now more concerned about economy/inflation rather than COVID (unlike during Trump era). Fed may go for liftoff from March’22 itself rather than waiting for another quarter (June’22). Fed may hike at least 4-times in 2022 and 2023, while going for QT from June/July’22 despite lingering Omicron/COVID uncertainty and possible subdued economic data. Thus various Fed Governors are now actively preparing the market for a faster tightening and lower inflation expectation (at least). Subsequently Gold is under stress.
But Fed’s liftoff in March’22 may be dependent on COVID/Omicron curve, which is still parabolic and may not flatten meaningfully before Mar’22 or even June’22, when the pandemic is expected to transform into endemic due to huge natural and artificial vaccinations (Omicron/COVID infections and recovery is acting as a natural vaccination). Thus Fed may wait for actual COVID/Omicron data and its impact on economic activity till at least March’22, when the QE tapering will also be completed.
Fed may go for liftoff from June’22 rather than Mar’22 and QT from September or December’22 rather than June’22 amid lingering COVID uncertainty. But Fed will use its jawboning power and actively talk about QT (to start in 2022) to manage/minimize inflation expectations. Although December employment (Household survey) addition is around 651K and the headline unemployment dips below 4%, in January, it may remain subdued amid lingering Omicron disruptions. The December NFP report covered up to 12th December and the Omicron spikes began from the 3rd week of December, just before Christmas/holiday traveling season.
Fed may use its January meeting (26th) to highlight this point and adjust the market expectations of the March rate hike to June. And Fed will go for QT from June’22 to September or December’22. Fed is dependent on economic as-well-as COVID data. Fed is also mindful of elevated inflation and its impact on ordinary Americans and the vote box (politics). Thus to balance economic/employment recovery and price stability, Fed will take careful steps while going for gradual normalization, keeping financial stability. Thus Fed will telegram its path of normalization in the Mar’22 policy meeting with fresh economic projections (SEP/dot-plots).
Fed will look into three charts mainly in Q1CY22-inflation (core PCE), employment, and also COVID curve and may go for liftoff from Mar’22 and QT from Sep/Dec’22. Fed is already preparing the market for successive rate hikes and QT. Now the question is whether the Fed liftoff would be Mar’22 or June’22?
As a result of hawkish FOMC minutes, elevated inflation, and substantial progress of maximum employment, the market is now assuming faster Fed tightening. Thus US bond yields are soaring and approaching 2.00%. But at the same time, elevated inflation in the EU, Japan, and the U.K. coupled with the indication of withdrawal of pandemic monetary stimulus by ECB, BOJ as well as BOE is also supporting EUR, JPY, and GBP against USD.
Subsequently, EURUSD surged, while USDJPY slipped (after making a multi-month high around 115.50). GBPUSD also jumped as BOE may hike multiple times in 2022 and as Omicron restriction was proved to be less severe than earlier expected. Thus, overall higher US bond yields, but lower USD is resulting in almost flat movement in Gold. Fed Chair Powell said Omicron uncertainty is a risk to the economic outlook, but as of now, being more infectious & less deadly, it may not lead to Delta-like wave/panic/lockdown and thus the process of monetary policy normalization should not be affected. And Fed is adapting its policy to evolving inflation scenario which is fast turning sticky from transitory and thus Fed is now moving quickly from tapering to tightening.
There is a globally coordinated monetary policy tightening ignited by Fed to fight surging inflation. All major central banks like Fed, ECB, BOJ, and BOE are preparing for the gradual withdrawal of pandemic era monetary stimulus, which is now no longer required. Thus global bond yields are getting higher and inversely bonds are going lower along with Gold. Omicron disruptions, especially lockdowns in China to ensure zero COVID policy may lead to more issues for the global supply chain and hotter inflation in the AEs (U.S./Europe), positive for bond yields, negative for Gold, despite Gold being traditionally seen as an inflation hedge safe-haven asset.
But at the same time, Gold may be also buoyed by lingering COVID uncertainty, elevated inflation, public debt, deficit & devaluation of paper currency coupled with lingering geo-political uncertainty (Russia-Ukraine, China-Taiwan, and North Korea-South Korea/Japan/US). But the biggest driver in 2022 will be the Fed’s actual pace of tightening. And growing policy divergence between Fed and ECB, gradual weakness of EURUSD is also negative for Gold. Also, the COVID pandemic may soon turn endemic by mid-2022 amid significant progress of artificial as-well-as natural infections, which would be negative for Gold.
Technically, whatever may be the narrative, Gold now has to sustain over 1835 zones for a further rally to 1851/1875-1900/1920 areas; otherwise sustaining below 1830, Gold may slip to 1805/1785-1758/1730-1705/1675 in the coming days.
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