During the first 6 months of 2021, the yellow metal exchange rate showed a fairly stable dynamics due to inflationary expectations and the Fed's soft monetary policy. Precious metal quotes kept the weak dollar and economic stimulus packages high.
Strong Fed action
Recently, the US Central Bank quite unexpectedly reported on the planned tightening of monetary policy, which contributed to a significant jump in bond yields and the strengthening of the dollar. This led to a 7% drop in gold quotes, despite the fact that the dynamics of precious metal remained inversely proportional to the movement of the dollar index.
The minutes of the last meeting of the Federal Open Markets Committee indicate that the US central bank has taken a more aggressive position. Currently, the Fed continues to purchase $80 billion in bonds every month, and $40 billion in mortgage securities.
Representatives of the regulator said that a discussion will soon be initiated on reducing economic stimulus measures. In addition, it is planned to increase rates at the end of 2023. News of a possible tightening of monetary policy served as a catalyst for the growth of the dollar, which put downward pressure on gold.
However, at the same time, the Fed wants to increase employment and stabilize prices (inflation).
Inflation growth and monetary policy
Gold is considered a hedging instrument, but this year this asset does not fulfill its function. The consumer price index (hereinafter - CPI) of the United States significantly exceeded the Fed's forecast indicator by almost 2%. Rising inflation expectations lead to a tightening of monetary policy, which prevents an increase in precious metal quotes. However, the Fed's actions to reduce inflation conflict with the need to simultaneously maximize employment.
What happens in the labor market?
According to representatives of the Fed, at the moment the level of employment is a more serious problem than inflation. The employment rate in the United States is lower than in the period before the pandemic. The authorities are trying to reduce the unemployment rate from 5.8% to 4.5%. However, there is a risk that too rapid monetary tightening could jeopardize growth prospects and the current employment situation.
Gold Exchange Prospects
As already noted, monetary policy remains a key factor for the gold market. A reduction in economic stimulus measures and an increase in interest rates will most likely take place in the long term. Interest rates will not change for at least 2 years. The Fed predicts such average interest rates: in 2021 - 0.00%, in 2022 - 0.125%, in 2023 - 0.625%.
The prospects for the dollar and gold, in turn, will depend on employment and inflation data. Inflation is expected to rise in 2021, and the pace of employment recovery will slow down. Interest rates will be low for a short period, reducing the alternative costs of yellow metal ownership. The recent fall in gold prices may also lead to renewed interest in precious metal investments, which will come in handy in a balanced and diversified portfolio. Conditions for stock markets remain favorable, but the situation is unlikely to be stable in the long run. The probability of correction increases. In this scenario, gold prices will rise sharply.
Thus, an upward long-term trend in gold quotes should be expected to continue, or at least stabilize at least below current levels. In the latter case, long-term investors will have the opportunity to enter this market.