Gold drops nearly 5% after Fed ups inflation forecasts but signals higher interest rates

Gold suffered its biggest one-day percentage drop of the year on Thursday as a hawkish turn by the Federal Reserve lifted the U.S. dollar, sending prices for bullion to their lowest settlement in nearly seven weeks.

“Basically, officials revising the timetable for interest rate hikes [have] brought a taper tantrum for the gold price,” said Naeem Aslam, chief market analyst at AvaTrade, in a market update late Wednesday. “For investors, the opportunity cost of holding non-interest bearing assets have increased and gold has become [a] less attractive asset for them for now.”

August delivery, gold GCQ21, -0.29% GC00, -0.29% fell $86.60, or nearly 4.7%, to settle at $1,774.80 an ounce. On Wednesday, prices for the contract edged up by 0.3% on Comex, and snapped a three-session losing streak, but prices began falling shortly after the Fed announcement.

Prices for most-active gold futures settled at the lowest since April 30, according to FactSet data

While the Federal Open Market Committee held its policy interest rate steady and made no change to its asset buying program on Wednesday, it also signaled an interest rate rise soon than expected, with its forecasts suggesting two increases in 2023. And the Fed lifted its inflation forecasts for this year and next.

Recent data showing surging prices had led many to believe the Fed would at least begin early discussions about reining in some of its ultra-accommodative policy aimed at cushioning the economy from the COVID-19 pandemic, but the policy statement was more hawkish than some expected.

Gold prices have been under pressure, losing more than 5% so far this week. Based on the most-active contracts, Wednesday’s decline would mark the biggest one-day percentage drop since Nov. 9, when prices fell 5%.

Still, Adam Koos, president of Libertas Wealth Management Group, believes that this is a “news driven” move for gold, and those are typically short lived.

“This sharp move lower is probably a temporary one,” and the market will likely see, “at a bare minimum, a mean reversion until the next catalyst arrives,” he told MarketWatch.

That catalyst may come when Basel III international regulations come into play on June 28 for European banks, he said, explaining that gold will be reclassified to a Tier I asset, right alongside cash and currencies, from a Tier III asset, the riskiest asset class.

Since gold will have ‘risk free’ status, this could prompt banks around the world to continue to buy more, said Koos.

For now, gold prices have dropped, as the Fed’s hawkish turn sent bond yields surging, with that of the 2-year Treasury note TMUBMUSD02Y, 0.254% hovering at the highest levels in a year at 0.213%. The ICE Dollar Index DXY, +0.47% surged 0.8% to 91.86.

Investors should hardly be surprised about the prospects of a Fed interest rate increase in 2023, though the combination of a stronger U.S. dollar and rising yields do pose big hurdles for the precious metal, Carsten Fritsch, analyst at Commerzbank, told clients in a note.

“Whether it justifies a price slide on this scale is another matter, however. After all, gold had already fallen in recent days in anticipation of a possible change in direction on the part of the Fed. In our opinion, interest rate increases in two years’ time are too far off to warrant any such slump in price, especially as yields are well below the expected rate of inflation,” said Fritsch.

And he noted that Fed Chair Jerome Powell said the possibility of exiting bond purchasing was discussed but no decision was taken, so the central bank will continue to buy bonds amounting to $120 billion each month, further boosting its balance sheet and money supply.

“We view the pronounced slide in the gold price as excessive, though it is likely to take some time before the setback has been digested,” said Fritsch.

Also posting a loss was July silver SIN21, -0.48%, which slid $1.96, or 7%, to settle at $25.86 an ounce. That was the lowest finish since April 20.

July copper HGN21, -0.84% fell 4.7% to nearly $4.18 a pound , in a week that has so far seen the metal drop over 8%.

“Silver fell, along with gold, and may be partly governed by future gold moves, but silver…is also influenced by base metals price moves, notably but not exclusively copper prices,” said James Steel, chief precious metals analyst at HSBC Securities, in a note late Wednesday. “Copper and other base metals, after racing higher this year, have corrected. More supply may be on the way.”

On Wednesday, China’s National Food and Strategic Reserves Administration said it planned to release copper, aluminum, zinc and other national reserves in batches in the near future, to ensure the supply and price stability of bulk commodities.

July platinum PLN21, -0.54% slid $86.70, or 7.6%, to $1,055.20 an ounce, while September palladium PAU21, +0.09% tumbled by $324.60, or 11%, to $2,512.20 an ounce. Palladium saw its biggest percentage single-session drop since March 2020.