On one hand, safe-haven demand provides bullish support for gold. Middle East escalation and general geopolitical uncertainty drive XAUUSD higher as investors flock to safe assets. Additionally, structural buying on the part of sovereign wealth funds and global central banks continues to support prices.
On the other hand, rising interest rates and Treasury yields create severe headwinds for non-yielding gold. Tensions in the Persian Gulf have disrupted oil supply and pushed crude oil benchmarks higher. Higher oil prices raise future inflation expectations and increase the probability of rate hikes, thus strengthening the U.S. dollar and weighing on gold. In fact, 30-year real yields recently hit 2.987%, the highest since 2008. This is a critical point for gold, as rising real yields directly erode its relative attractiveness vis-à-vis other assets.
And this is not a U.S.-only story. The cost of capital is rising in other economies as well. The European Central Bank (ECB) recently held its rate at 2.25%, but markets are pricing in an 80% chance of a September hike. In its statement, the ECB noted that ‘uncertainty remains high and the full inflationary impact of the energy shock has yet to play out’. The Reserve Bank of Australia (RBA) is also expected to raise rates after a strong employment report showed that an addition of 76,000 jobs were created in June. Elsewhere, 2-year Japanese Government Bond (JGB) yields reached a 31-year high on rate-hike expectations, while the German 10-year Bund yield surpassed 3.2% for the first time since 2011.
All of this shows that monetary policy is tightening across the globe, and gold is likely to suffer as a result.
Key scenarios for XAU/USD
Although the market expects the Fed to leave rates unchanged, interest-rate swap market data indicate that the chances of a 25-basis-point rate hike are around 33%. This means that a rate hike is more than likely, which could trigger a very strong reaction, irrespective of the actual decision.