Gold pauses post US Fed decision; higher interest rates is negative for yellow metal, says Madhavi Mehta of Kotak Securities

Gold witnessed a sharp correction in the last few days as market players played down risks associated with Russia-Ukraine reducing its safe-haven appeal while correction in commodity prices also reduced its demand as an inflation hedge.

The recent leg of correction was amid positioning for the US Fed decision.

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Madhavi Mehta – Associate Vice President - Commodity Research at Kotak Securities decodes where gold prices are headed and the impact of US Fed rate hike:

Gold briefly slipped below the key $1900/oz level just before the US Fed decision but witnessed a sharp rebound post the decision and moved closer to $1940/oz level.

It can be seen as a general case of selling the rumor, but the fact is that market players are also assessing Fed’s future stance given uncertainty both on inflation and economic growth.

The US Federal Reserve decided to raise its key lending rate from 0-0.25% to 0.25-0.5%, the first hike since the start of the pandemic, in line with market expectations.

Earlier this month, market players were expecting a sharper 0.5% rate hike but pared down expectations as Russia-Ukraine tensions challenged global economic activity.

Fed’s rate hike decision showed that the central bank wants to take a gradual approach amid persisting challenges.

The US Fed highlighted that implication of the Russia-Ukraine conflict on the US economy remains highly uncertain but could exert upward pressure on inflation and weigh on economic activity in the near term.

Fed’s economic projections are also painting a mixed picture. Fed has projected six more rate hikes by end of 2022 which will bring the key lending rate to 1.75-2%.

This is largely in line with market expectations as the central bank remains intent on bringing inflation under control. Fed has also raised inflation forecasts highlighting persisting worries about rising price pressure.

The Fed raised the 2022 inflation forecast from 2.6% to 4.3%. Fed has also raised inflation forecast for the next two years indicating that price pressure may not come under control soon. Adding to it is uncertainty about the impact of Russia-Ukraine fighting on commodity and energy prices.

In the post-meeting conference, Fed Chairman Jerome Powell justified the rate hike stating that the US economy is strong enough to handle monetary tightening.

Fed’s economic projection however shows a bleak outlook. Fed has lowered the 2022 GDP growth estimate from 4% to 2.8%, a steep revision that reflects increasing uncertainty owing to geopolitical risks and withdrawal of pandemic era stimulus measures.

Fed has started the monetary tightening cycle as it wants to send a signal that it is working to get inflation under control.

The US Fed has six more planned meetings this year and forecasts indicate that there will be one 25 basis points hike per meeting.

Fed has set the course and at every meeting, it will counter inflation against growth before taking a decision. The growth outlook will remain challenged unless there is a resolution to the Russia-Ukraine conflict and sanctions imposed on Russia are scaled back. A rise in borrowing costs and tightening liquidity conditions could also challenge economic activity.

Fed’s monetary tightening is negative for gold as higher interest rates increase the opportunity cost of holding the metal. Gold has however managed to hold firm amid expectations that the central bank may take a gradual approach as it balances growth against inflation.

Additionally, rising inflationary pressure and fear of supply shocks have also increased gold’s appeal as an inflation hedge.

(Disclaimer: The views/suggestions/advice expressed here in this article is solely by investment experts. Zee Business suggests its readers to consult with their investment advisers before making any financial decision.)