Dollar Strength Causes Gold to Drift Lower, and Friday’s CPI Will Reveal if Inflation Continues to Spike Higher

The dollar gained 18 points today (+0.19%) taking the dollar index to 96.295. The United States 10-year treasury note gained 0.078 taking its current yield from 1.357% to 1.435%. Collectively Treasury yields and dollar strength put fractional pressure on gold today with the most active February 2021 Comex contract currently fixed at $1779.40. This is a net decline of ¼%. Gold opened at $1787.70, traded to a low of $1776.40 for settling just below $1780.

The next report which will influence gold and silver pricing will be released on Friday when the United States releases its Consumer Price Index. Currently, the CPI is fixed at 6.2%, its highest level since November 1990. If inflationary pressures continue to climb it would be initially bullish for gold, with the caveat that a higher rate of inflation would pressure the Federal Reserve, even more, to accelerate tapering their monthly asset purchases so that they can raise rates sooner.

A large spike in inflation could certainly re-shape the monetary policy of the Federal Reserve in terms of the number of rate hikes it plans to implement next year. That is the double-edged sword of inflation; it creates bullish market sentiment as gold has typically been one of the better hedges against inflation, however, it also creates bearish market sentiment as it forces the Federal Reserve to raise interest rates as well as the number of rate hikes in 2022.

The FOMC meeting in February will contain an extremely important piece of information which is their updated monetary policy vis-à-vis the “dot plot”. This is the most comprehensive information about how voting members anticipate raising rates over the next few years. Up until recently, the Federal Reserve’s monetary policy was looking to have no rate hikes both in 2021 and 2022. That policy was updated recently, and will probably be updated this month.

The Federal Reserve let inflation run hot and focused instead on achieving maximum employment, the other component of their dual mandate. In light of that, the Federal Reserve was extremely mistaken assuming that inflationary pressures were transitory and would abate as quickly as the end of this year. As they adjusted their projections, they believed that it would abate by the middle of 2022. However, in both cases, they most likely got it wrong. Current sentiment favors the belief that inflationary pressures could continue throughout 2022. That puts the Federal Reserve in the position of having to quickly act to temper the rate of inflation.

But raising rates too quickly is also a double-edged sword. Higher rate interest rates do pressure inflation lower but at a very high cost. The cost is the slowing economy and recovery. Economic contraction brings a new set of issues that the Federal Reserve will attempt to deal with. In other words, they are facing a balancing act that is almost impossible to correctly implement. Because there is no clear solution that will curb rising inflationary pressures and not have a profound negative impact.

In other words, they’re damned if they do, and damned if they don’t, but forced to act.

Wishing you, as always, good trading and good health,

Gary Wagner