Gold forecast: Fed rate cuts may deliver a bust for bullion bulls

• Gold has been inversely correlated with the US dollar and bond yields recently
• The Fed is about to cut rates but that may not benefit bullion initially
• Strong US economic data or market turmoil could deliver near-term gold weakness

Overview

We’re fast approaching what are arguably the most important two days for markets this year with upcoming US economic data likely to determine how fast the Fed will have to move when it comes to reducing interest rates. Even though lower borrowing costs and a weaker US dollar would normally boost the gold price, in the near-term, rate cuts – be they big or small – may deliver a bust for bullion bulls.

Gold’s longer-term drivers in control

It's no secret that gold often exhibit an inverse correlation with the US dollar and interest rates. As a non-interest-bearing asset conventionally priced in US dollars, it makes perfect sense that gold often outperforms when they’re moving lower.

We’ve seen that again recently with gold’s rolling 60-day correlation with the US dollar index (DXY), US two and 10-year Treasury yields, and US inflation-adjusted 10-year Treasury yields deeply negative over the past quarter. 

But Fed rate cuts may not deliver further upside initially

I don’t expect the relationship will diminish meaningfully over the medium to longer-term, but in the short-term, even though the Fed is set to begin cutting interest rates it may not benefit gold.

Here are two reasons why.

The first is markets have already priced a lot of rate cuts from the Fed with 113 basis points of easing expected over the next three meetings, implying at least one move will be a whopper. That means it’s now up to the data to justify this increasingly dovish pricing. If it doesn’t, the next chart suggests gold’s tailwinds from a softer dollar and lower bond yields could turn to stiff headwinds.

It looks at the rolling 60-day relationship between 2024 Fed rate cut pricing, according to Fed funds futures, and US two and 10-year yields with the US dollar index (DXY). The DXY has been strongly correlated with each over the past quarter, suggesting that if the US data casts doubt on the need for the Fed to cut aggressively, the likely rebound in US yields may drag the dollar higher. That’s not likely to help gold.

While data resilience is a risk given how rich rate cut pricing is, my base case is that it will continue to soften, adding to the risk of the Fed having to move aggressively. But hold your horses if you think that will put a rocket under the gold price.

That could happen, but if it is having to dole out supersized cuts left, right and centre, history suggests it may be accompanied by turbulence in riskier asset classes and elevated recession fears. 

Even though gold is a safe haven, it is often liquidated to cover losses in other asset classes during the initial stages of market turmoil. That occurred in the panic in early August, warning of a similar outcome should US economic concerns return again.

In the near-term, supersized Fed rate cuts may deliver gold weakness even though it may provide medium to longer-term tailwinds.  

Gold capped below record highs

Looking at gold on the daily, it has settled into a narrow range heading into this period of elevated event risk with sellers capping advances over $2500 while buyers have been nibbling dips below $2480, as seen with the two big downside wicks on the candles earlier this week.

On the downside, support is noted at $2470, uptrend support around $2440, along with $2436.87. Unless we see a major risk off episode, moves below these levels may be difficult in the near-term. On the topside, if bullion gets a foothold above $2500 a retest of $2531.81 appears likely.

MACD and RSI (14) are providing bearish signals on momentum, adding to the need for caution for those seeking fresh record highs

-- Written by David Scutt

Follow David on Twitter @scutty