FOMC to Hold, Gold Waits for Dovish Sign

Gold prices have come under pressure this week amid easing geopolitical conditions and rising expectations of a hawkish Fed, but there are indications that the market may get a dovish surprise.

What's Moving the Market

• The market sees an almost 70% chance of a hold, with a hawkish bias as traders expect Warsh to lay the groundwork for a September hike.
• Weaker data since the last meeting might lead to a dovish surprise if the Fed draws attention to softer June jobs numbers or downplays inflation risk from higher energy prices.
• Gold prices have come down this week as the focus has shifted from easing geopolitical tensions to a tightening monetary policy outlook.

Fed to Hold, Eye Inflation

The market has grown increasingly uncertain about the US monetary policy outlook amid surging consumer prices and harsh rhetoric from the new Fed Chair about controlling inflation. The shift has generally been towards greater hawkishness, and markets are now virtually pricing in a rate hike by the end of the year. The uncertainty lies in the timing, with markets dithering on whether it will be in September or October. Wednesday's meeting, and perhaps more crucially, the FOMC Chair Kevin Warsh's remarks, will likely firm up those expectations and prompt moves in the dollar and gold.

Markets see nearly perfect two-thirds odds of a hold, with dissenters expecting a 25 bps hike. With the odds of a September hike over 80%, markets are anticipating that Warsh will lay the groundwork for the first hike of his tenure. However, he's made a point of not providing forward guidance, and traders might be disappointed by his lack of clarity, taking it as a sign of dovishness. Markets seem to have forgotten that Warsh was appointed by the notoriously dovish Trump and have been taking him at his word about fighting inflation. However, there are additional mechanisms to reduce price pressures beyond raising rates, and Warsh has shown a preference for them in the past. Additionally, since the last meeting (which surprised markets by its hawkish tone), inflation has been softer than expected, with the core rate actually cooling, and payroll numbers have been weaker. Despite the data, markets have increased their odds on a rate hike, while Warsh has tried to convince Fed watchers that data is more important than forward guidance.

How to Read the Fed's Message

The relatively high odds of a hike could leave the market with a dovish reaction, even if the Fed delivers as expected with a hold. What could offset that is an accompanying hawkish statement. Traders will be looking for a change in emphasis from the prior statement to see whether it includes any reference to the shift in data released in June. A focus on inflation will likely keep the market on track to expect a rate hike in September, while a mention of easing in the labour market would be seen as a dovish surprise. Another factor is whether there are dissenting votes, which is typically unusual for the Fed. There won't be an update to the dot-plot matrix or economic projections, so the market will pay much closer attention to Warsh's comments. The thing is, because the markets are practically pricing in a rate hike at the next meeting, there is little room for a hawkish surprise. But there is plenty of room for a dovish surprise, including Warsh's inexperience in cajoling the market. This puts the odds of a surprise in favour of supporting gold, as a lower chance of a rate hike would be seen as positive for precious metals.

Gold Potential Triangle Pattern in Focus

Gold has traded over $4K for most of the second half of July, with short-term support at $4020, where the lower Bollinger Band sits on the 4-hour chart. A breakdown of the minor support could open the door to $3900 and lower, should $3960 and $3940 give way to potential bearishness, which would increase the odds of a triangle continuation. On the flip side, reclaiming the middle band at $4070 and the regional resistance at $4115 (clusters with upper BB) could pave the way for the local peak at $4165. As a result, the yellow metal might head towards $4200.

Source: SpreadEx | Gold,  4-hour Chart