Inflation is Hot and Getting Hotter

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Inflation has been the talk of the town for months now. Inventory shortages, supply chain bottlenecks and other issues have all been linked to the steep rise in  U.S. inflation in recent months. Inflation has become so problematic at this point that even the Federal Reserve has acknowledged it after saying it believed it was only transitory in nature for a long period of time. Today’s latest reading of the Consumer Price Index only adds credibility to the argument that inflation is entrenched and here to stay. The gauge registered its highest reading in decades today, showing an annual price rise of a whopping 7.5%.

 

The 7.5% reading was above consensus estimates for a rise of 7.2%. The hottest inflation reading in some 40 years has put pressure on both stocks and the metals complex. The data falls clearly into the camp of the policy hawks, who want to see the Fed act aggressively with multiple rate hikes to battle rising price pressures. The reading also fueled a spike higher in treasury yields which is also adding pressure to the metals in early morning action. The benchmark 10-Year Note is currently fetching a yield of 1.994%, its highest yield in over two years.

 

The notion of runaway inflation is not new nor should it be discounted. The Fed has seemingly been well behind the inflation curve for some time now. The central bank could, therefore, be forced to act far more aggressively than previously anticipated. This aggressive action could come in several forms, including a faster pace of more rate hikes or a stringer hike to begin with. The Fed has not made a half-point rate increase since 2000, at which time the dot.com bubble burst and stocks went sharply lower. Some analysts have suggested that hot inflation could pave the way for the Fed to hike rates by a half-point in March rather than the standard quarter-point rise. While such a move could potentially help ease the rise of inflation, it is not without risks. Stock markets, for example, do not love the idea of higher interest rates. The era of free, easy money has been a major contributor to stock market upside in recent years, according to some, and without it the equity markets could potentially see a major slide and trend reversal.

 

Although gold is slightly higher this morning, the metal may remain range bound until the Fed does actually take action. The metal could see a rise during this tightening cycle as it has during previous tightening cycles, and moderately higher interest rates may not be enough to halt buying interest in the yellow metal. The bulls are not far from a key level they must breach. A close above the $1850 area could indicate a fresh leg higher for gold. The bears are targeting a close below $1800 and $1780. A close beneath these levels could set the stage for a fresh leg lower.

Bulls Gaining Some Ground

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As the new trading week gets underway, the gold bulls are seeing some further bullish momentum. Spot gold prices are up $12.80 per ounce today as equity markets see some afternoon buying. Inflation worries appear to be the primary driver of market action today. With corporate earnings generally being quite strong, investors today are continuing to digest last week’s non-farm payrolls data which was stronger than expected. The better than anticipated jobs data may act as a green light for the Fed to begin hiking interest rates next month and could pave the way for a series of hikes this year.

 

The Fed raising rates in just a few weeks time has markets worried but not overly so, at least thus far. While the Fed has already penciled in three interest rate hikes for 2022, many analysts believe the central bank will be forced to hike rates at least four times, possibly even more. Of course, the pace of any Fed rate hikes will likely largely depend on inflation and whether price pressures abate at all in the weeks and months ahead. Recent data would seemingly suggest, however, that price pressures may continue to rise and run rampant. The Fed seemingly has realized it is well behind the inflation curve already, and the central bank may act far more aggressively, therefore, than previously thought.

 

An increasingly aggressive Fed is not necessarily a bad thing for gold. The gold market has risen through previous rate hiking cycles and there is no reason to believe that this time around will be any different. The Fed tightening could affect stocks and risk assets, however, and may lead to a long period of heightened volatility and major stock sell-offs. A full-blown trend reversal is also a strong possibility. As equity markets come under increasing pressure, much of that capital could find its way into the gold market as investors seek out alternative places to put money to work. Such a scenario could, in turn, act as a major catalyst for higher gold prices, possibly even driving the metal into fresh all-time high territory.

 

In addition to the threat posed by inflation and the Fed, markets will also continue to monitor the crude oil market, the dollar and other geopolitical issues. Although it is trading lower today, crude oil prices are now firmly in the 90s and many feel that $100 per barrel oil will be seen soon. While stronger crude may be partly due to the inflationary environment, it is also the “leader” of

the commodity sector. Higher oil may, therefore, drag other commodities higher as well along with it. This could feed into the current inflation narrative and force investors to seek out asset classes that may provide protection and preserve purchasing power. It is difficult to imagine such a scenario in which the value of gold does not increase and increase substantially.

 

In the meantime, the bulls will look for a close above the January highs in the mid- $1850s while the bears will target a decline to the January lows around $1780.

Gold Holding Above $1800

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The gold market Has seen some reversals today as overnight gains were wiped out following the surprisingly strong jobs data for January. The market has since recovered, however and is back in positive territory, albeit not by much. Spot gold prices are currently up less than $2.50 per ounce. The important thing today, however, may be the metal’s willingness to hold above the key $1800 level.

 

The January Non-Farm Payrolls data released this morning showed a much stronger rise in jobs compared to consensus estimates. While estimates were looking for a rise of 150,000 jobs, the report showed that jobs rose by some 467,000. The January unemployment rate was at 4%, and other internal components of the report were also stronger than anticipated. Like it or not, the report may provide some credibility for the Fed and its plans on raising interest rates beginning as soon as next month. The jobs data is definitely hawkish and may back up recent hawkish Fed rhetoric.

 

Although gold and other markets have plenty of issues to consider currently, central banks and their monetary policies remain at the center of attention. Thursday’s ECB meeting was viewed as being more hawkish, with commentary from its President, Christine Lagarde, being seen as increasingly hawkish. The rise in hawkishness from the ECB seems to be following the recent rise in U.S. hawkishness. If inflation continues to be a problem or increases further, central banks may become even more aggressive both in rhetoric and action. This could potentially lead to a more rapid rise in interest rates than expected or more rate increases than previously thought. Whether central banks hike more, faster, or both, the notion of rising rates could spell trouble for equity markets and risk assets.

 

The crude oil market may provide gold with a boost in the weeks ahead. Crude is trading higher today to finish off the trading week and is now valued at a seven-year high. With crude now at nearly $92 per barrel, traders are likely eyeing the $100 level as the next stop and prices could see a continued push until they get there.

 

The daily charts show a slight bullish advantage. The bulls will need to target first resistance around $1825 followed by a test of resistance in the $1850 area. The bears are looking for a decline to the $1775 level followed by a run lower to the December lows.

 

With the yellow metal holding above the key $1800 level, the bulls will need to act and act soon to avoid a bearish decline. The patience of longs within the market could eventually run out, otherwise, and many could throw in the towel if gold is unable to make any further advancement. With interest rates set to possibly rise as soon as next month, volatility could possibly see an increase as investors and traders square positions ahead of any moves by the Fed. The gold market has risen during past tightening cycles, however, and there is no reason for it not to do the same during this cycle.

May More Forecasts Be Lowered?

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The gold market is seeing some shifts in expectations for the year ahead. Rising inflation, an increasingly aggressive Fed and other factors may all have significant effects on gold and could keep it on the defensive in the year ahead. The gold bulls did make some upside headway today, however, as they look to distance the market from key $1800 level. Spot prices are up nearly $6 per ounce in late afternoon action, now sitting at $1806 and change.

 

Market expectations for gold have seen some significant shifts in recent weeks as market dynamics have been changing. Scotiabank today lowered its gold forecast for 2022 to $1800 per ounce. The bank reportedly sees Fed tightening of monetary policy as a major hurdle to higher gold and believes that gold is likely to maintain its recent range throughout 2022.

 

Scotiabank’s Tuesday report highlighted the notion that the Fed is looking to hike more and faster than previously anticipated. Markets may now, in fact, be pricing in five rate hikes rather than the three the Fed currently has penciled in. The Fed has also set up plans to shrink its balance sheet as well and the combination of that and rising rates may keep the gold bulls limited.

 

Although rising interest rates may provide some headwinds for the gold bulls, the metal is unlikely to see a major price route this year. Problematic inflation is likely to keep a solid floor underneath the gold market as the year progresses, regardless of how high rates may get lifted. In addition to inflation, the bulls may also be able to rely on general market uncertainties and the potential for an equity market sell-off or reversal.

 

The downgraded forecast from Scotiabank may not be the last downgrade. More banks may decide to shift their market expectations as well in the weeks ahead. Of course, just how far the Fed may be willing to go remains unknown. The Fed has sounded considerably more hawkish in recent commentary. The Fed has sounded increasingly hawkish before, however, and elected not to act upon their hawkish rhetoric. If the Fed does not follow through on rate hikes this time around, however, inflation could spiral out of control and leave the Fed grasping for a solution. The Fed seems to understand it is already well behind the inflation curve and it does not appear willing to risk a major price ascent from current levels.

 

Despite some recent selling, the gold bulls still have control on the daily chart. That control could be considered quite fragile, however, and they will need to demonstrate further strength and do it soon to maintain that control. With the market back above the $1800 level, the bulls will again target a run towards resistance in the $1850 region. The bears will look to take prices back below the $1800 level and then try for a close below support at $1775. Whether the bulls or bears win the next round, it could potentially lead to an extended move in that direction.