Gold price outlook improves as analysts weigh Fed policy mistake, hot inflation data

The price outlook for gold is looking better going into the third week of the new year. Analysts are weighing the consequences of a potential monetary policy mistake as the Federal Reserve gets more hawkish amid the latest inflation data.

The threat of inflation is finally pushing gold higher as investors expect price pressures to continue climbing. February Comex gold futures were last trading at $1,816.90, up more than 1% on the week.

The two key datasets keeping markets in a risk-off mood are inflation and retail sales. In the U.S., inflation ran at the hottest pace since 1982 in December, rising 7% over the past 12 months. Meanwhile, retail sales were down the most in ten months, falling 1.9%.

The two big drivers for gold going forward will be the U.S. dollar and bond yields. The dollar has retreated, giving some breathing room to gold, while the bond yields have just paused their climb.

"Take a look at how high Treasury yields have run. The market is pricing in well over 90% chance that the Fed will raise rates in March. And gold is having its best week in a couple of months," OANDA senior market analyst Edward Moya told Kitco News. "Gold is not able to break beyond its recent highs, but things are looking pretty good."

Gold is watching where the U.S. dollar goes from here. The European recovery along with some new euro strength could play a critical role in determining the greenback's direction.

"There are a lot of conflicting outlooks for where the dollar is going to go. You should start to see better global economic recovery, which would drive a lot of European growth potential and could deliver a weaker dollar. The euro growth story got deferred from 2021 to 2022," Moya explained.

Also, the latest inflation readings push the Fed to act quickly as it appears to be behind the curve. "They are scrambling. We'll see as far as the balance sheet goes. This will dictate what happens with the back-end of the yield curve — one of the more important drivers for gold. And the back-end is struggling to steepen," Moya added.

After a rate hike in March, the second increase could come in June, along with a balance sheet runoff. This is where analysts will start to worry about a potential policy mistake and its impact on the economy. "One of the things that no one has a strong handle on is the risks to the U.S. economy. The Fed policy could possibly invert the curve in the next year or two. All these risks are growing," Moya stated.

Last year, the Fed said to expect growth and very slow rate hikes. But instead, we are seeing 7% inflation and an aggressive tightening, Moya pointed out. "Chances of a policy mistake could be positive for gold. Longer-term, you'll see demand for bullion because of that," he noted.

Equities are likely to help gold move higher next week, said RJO Futures Senior commodities broker Bob Haberkorn. This is an unusual relationship for gold and equities, but it has been the COVID trade. "Gold has a chance to break higher next week. Equities will be a bit stronger, and that will push gold back up through the $1,830 level. The COVID trade has been lower equities, lower gold," Haberkorn told Kitco News.

Gold has struggled around the $1,830 level because of competing narratives of accelerating inflation and rising yields, Haberkorn added. "Yields are going higher with inflation running hot. And gold parked itself in a range. Those two narratives are competing. Next week, depending on how yields look, we could get to anywhere between $1,830 and $1,850," he said. "If bond yields weren't doing what they are doing, gold would be $50-$70 higher."

Moya is watching the $1,833 an ounce level next week. "If we can break that and then hold $1,840 an ounce for a day, and we could see bullish momentum," he said.

Data to watch

It will be a short trading week due to markets being closed on Monday for Martin Luther King, Jr. Day.

Dtasets to watch are N.Y. Empire State manufacturing index on Tuesday, building permits and housing starts on Wednesday, jobless claims, Philadelphia Fed manufacturing index, and existing homes sales on Thursday.

By Anna Golubova

For Kitco News

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