Gold sets to rally as soft inflation data boosts rate cut bets, US Dollar tumbles

Gold price is set to extend upside as the Fed is expected to cut rates sooner than anticipated.
The core PCE price index declined more than expected to 3.2% in November.
Action could be limited due to a thin-trading week.

Gold price (XAU/USD) looks set to rally further after a significant decline in the United States core Personal Consumption Expenditure price index (PCE) in November has boosted hopes of early rate cuts by the Federal Reserve (Fed). Market participants are pricing in the first rate cut by the Fed in March, and second in May after two years of historically rapid rate-tightening by the central bank.

Fed policymakers, who were endorsing higher for longer interest rates to ensure a return of inflation to 2%, may support an early reduction in borrowing costs. The current cycle in which interest rates have undergone tightening for a longer period may impact the overall state of employment in the economy. Hopes of interest rate cuts have propelled home prices higher, which remained muted from February 2022 till June.

Daily Digest Market Movers: Gold price advances while US Dollar refreshes five-month low

Gold price trades near a three-week high around $2,065 as a sharper-than-projected decline in the United States core PCE price index data has fuelled bets in favour of early rate cuts by the Fed.
The US core PCE price index data softened to 3.2% vs. the estimates of 3.3% and the former reading of 3.5%. On a monthly basis, the underlying inflation data grew slightly by 0.1% while market participants projected a steady growth of 0.2%.
It is worth noting that the Fed forecasted core PCE price index at 3.2% by the year-end in its Summary of Projections (SOP) released last week. This indicates that the Fed has achieved its inflation target of 2023.
This greater-than-projected decline in the Fed’s preferred inflation tool may force policymakers to endorse rate cuts sooner than previously thought.
As per the CME Fedwatch tool, market participants are pricing in a more than 71% odds chance of an interest rate cut in March. The likelihood of a second rate cut in May is more than 68%.
Till now, Fed policymakers have been pushing back rate cut expectations, citing the need for a restrictive interest rate policy for a longer period to ensure the achievement of price stability.
A significant decline in the US inflation data is setting a better start for the Fed for 2024, which would allow them to achieve a soft landing for the economy. Such a soft landing would enable price stability without triggering a recession.
Apart from the US core PCE price index data, investors also focused on the Durable Goods Orders for November, released on Friday.
New orders for durable goods rose at a stronger pace of 5.4% against expectations of 2.2%. In October, orders of durable goods contracted by 5.1%.
Subsiding inflation in the US economy has boosted consumer confidence. The Michigan Consumer Sentiment index for December, released last week, rose to 69.7, against projections and the former reading of 69.4.
The confidence of US residents in the economic outlook was also boosted by expectations of higher disposable income among households due to easing price pressures.
Meanwhile, annual home prices continued to accelerate in October amid deepening expectations of earlier rate cuts by the Fed.
The Federal Housing Finance Agency (FHFA) report showed that prices of residential properties grew 6.3% in October on a yearly basis, up from a former reading of 6.2%.
Deepening rate cut expectations by the Fed have weighed heavily on the US Dollar and Treasury yields.
Lower interest rates, or their expectation, tend to reduce foreign capital inflows negatively impacting a currency.
The US Dollar Index hovers near a five-month low below 101.50 and 10-year US Treasury yields have dropped further to near 3.87%.
This week, the economic calendar will be light due to it being a holiday week while the second-tier weekly jobless claims data will be in focus.

Technical Analysis: Gold price recaptures $2,070

Gold price hovers near a two-day high at around $2,066 in a thin-trading week. The precious metal is expected to remain sideways amid an absence of critical events ahead. More upside would appear if the Gold price manages to sustain above the crucial resistance at $2,070. Short-to-long term daily Exponential Moving Averages (EMAs) are sloping higher, pointing towards an upside bias. Momentum oscillators swing in a bullish trajectory, indicating a healthy trend to the upside.

Fed FAQs

What does the Federal Reserve do, how does it impact the US Dollar?

Monetary policy in the US is shaped by the Federal Reserve (Fed). The Fed has two mandates: to achieve price stability and foster full employment. Its primary tool to achieve these goals is by adjusting interest rates.
When prices are rising too quickly and inflation is above the Fed’s 2% target, it raises interest rates, increasing borrowing costs throughout the economy. This results in a stronger US Dollar (USD) as it makes the US a more attractive place for international investors to park their money.
When inflation falls below 2% or the Unemployment Rate is too high, the Fed may lower interest rates to encourage borrowing, which weighs on the Greenback.

How often does the Fed hold monetary policy meetings?

The Federal Reserve (Fed) holds eight policy meetings a year, where the Federal Open Market Committee (FOMC) assesses economic conditions and makes monetary policy decisions.
The FOMC is attended by twelve Fed officials – the seven members of the Board of Governors, the president of the Federal Reserve Bank of New York, and four of the remaining eleven regional Reserve Bank presidents, who serve one-year terms on a rotating basis.

What is Quantitative Easing (QE) and how does it impact USD?

In extreme situations, the Federal Reserve may resort to a policy named Quantitative Easing (QE). QE is the process by which the Fed substantially increases the flow of credit in a stuck financial system.
It is a non-standard policy measure used during crises or when inflation is extremely low. It was the Fed’s weapon of choice during the Great Financial Crisis in 2008. It involves the Fed printing more Dollars and using them to buy high grade bonds from financial institutions. QE usually weakens the US Dollar.

What is Quantitative Tightening (QT) and how does it impact the US Dollar?

Quantitative tightening (QT) is the reverse process of QE, whereby the Federal Reserve stops buying bonds from financial institutions and does not reinvest the principal from the bonds it holds maturing, to purchase new bonds. It is usually positive for the value of the US Dollar.

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