Rising expectations for high Fed rates cut a record fuel

• Gold gathered bullish momentum and set a new high this week.
• The short-term technical chart highlights the dominance of buyers.
• The Fed will announce its interest rate decision and release its revised dot chart next week.

Gold (XAU/USD) edged higher in the second half of the week to hit a fresh record above $2,580, boosted by growing expectations for a big rate cut by the Federal Reserve (Fed) at its next policy meeting . The Fed will also release its revised Summary of Economic Forecasts (SEP), which could provide important clues about the US central bank’s rate outlook and could drive the valuation of the precious metal next week.

Gold buyers dominate the action

After the sharp drop seen at the end of the previous week, gold recovered above $2,500 on Monday. In the absence of high-level macroeconomic data, falling US Treasury yields weighed on the US Dollar (USD), allowing XAU/USD to continue its gains on Tuesday.

During Asian trading hours on Wednesday, Bank of Japan (BoJ) Governor Junko Nagakawa said the BoJ was likely to adjust the degree of monetary easing if the economy and prices move in line with their projections. These comments triggered a sharp decline in the USD/JPY pair, further damaging the USD and opening the door for another leg higher in gold. Later in the day, the Bureau of Labor Statistics (BLS) reported that the consumer price index (CPI) rose 2.5% in August, down from a 2.9% increase in July. However, core CPI, which excludes volatile food and energy prices, rose 0.3% month-on-month, beating market expectations of 0.2%. US Treasury yields rebounded with the immediate reaction and forced gold to head south in the second half of the day.

On Thursday, the BLS reported that annual producer inflation, as measured by the change in the producer price index (PPI), fell to 1.7 percent in August from 2.1 percent in July. Gold climbed above $2,530 after the data and gathered new bullish momentum. Additionally, the decisive rally seen in the XAU/EUR pair after the European Central Bank’s (ECB) decision to cut its benchmark interest rate by 25 basis points (bps) suggested that gold has also managed to capture capital outflows from the euro.

Meanwhile, The Wall Street Journal reporter Nick Timiraos, who is widely regarded as a “Fed insider,” wrote in an article that the size of the Fed’s interest rate cut at next week’s meeting will be a close call. According to the CME FedWatch tool, the probability of a 50 bps rate cut at the September meeting climbed above 40 percent from nearly 20 percent Thursday morning. As a result, the benchmark 10-year U.S. Treasury yield continued to fall, allowing gold to extend its gains to a fresh record above $2,580 on Friday.

Gold investors await Fed policy announcements

The US economic calendar will present retail sales data for August on Tuesday. Investors expect a 0.2 percent monthly rise after July’s 1 percent rise. A negative print could make it harder for the USD to find demand and help XAU/USD rally. However, the market reaction is likely to remain short-lived, with investors refraining from taking large positions ahead of the Fed’s monetary policy announcements on Wednesday.

Market positioning suggests gold faces two-way risk heading into the Fed event. A 25 bps rate cut could boost USD with immediate reaction and cause XAU/USD to make a correction. On the other hand, there is room for further USD weakness if the Fed opts for a 50 bps rate cut.

In addition to the rate decision, market participants will also look at the revised SEP, also known as the dot plot. The CME FedWatch tool shows there is a greater than 90% chance the Fed will cut the policy rate by a total of 100 basis points this year, including the September rate cut. This positioning suggests that markets are forecasting at least one 50 bps rate cut and two 25 bps rate cuts in the last three policy meetings of the year. If the dot chart shows that policymakers expect the policy rate to be at 4.25%-4.5%, 100bps below the current rate, at the end of the year, XAU/USD would have a bullish boost even if the Fed announces a level of 25 bps. cut. On the other hand, a 25 bps rate cut, accompanied by a dot chart indicating a total 75 bps rate cut by the end of the year, could help US bond yields rebound and hurt gold.

Investors will also pay close attention to growth forecasts. A significant downward revision to growth forecasts could reignite fears of a recession next year and trigger a sell-off in US stock markets. In this scenario, the USD could hold its ground and limit its losses even if the Fed’s outcome is considered to be favorable.

In short, the Fed’s rate decision, the revised dot chart, and Fed Chairman Jerome Powell’s comments during the post-meeting press conference are sure to increase market volatility. There will be too many pieces in motion and it might be too risky to take a position, at least until the dust settles in the European morning the next day.

Gold technical outlook

The relative strength index (RSI) indicator on the daily chart remains below 70, suggesting that gold has more room to the upside before becoming technically overbought. The next resistance could be seen at $2,600 (round level) before $2,660 (the upper limit of the ascending regression channel coming from mid-February).

On the downside, $2,530 (static level, former resistance) lines up as first support ahead of $2,500 (static level, round level) and $2,460 (50-day SMA).