Gold Rebounds on Easing Geopolitical Tensions, Awaits US CPI for Next Direction

What happened

Gold prices experienced a strong rebound in the latter part of last week. This movement was fueled by news that former US President Donald Trump ruled out strikes on Iran before the November elections and mentioned productive discussions with the country. This statement eased geopolitical tensions, resulting in a pullback in Treasury yields and the US dollar, which historically benefits gold as a safe-haven asset.

Over the weekend, Iran stated that the US's response to its proposal to reopen the Strait of Hormuz was deemed insufficient. Tehran had outlined seven conditions for restoring normal maritime passage within seven days, and some points remain unresolved. Negotiations to address these differences are still ongoing, maintaining a degree of uncertainty regarding the geopolitical situation.

Why it matters

The interplay between geopolitical tensions and Federal Reserve (Fed) monetary policy expectations are the primary drivers of gold prices. Easing geopolitical risk, as seen with Trump's statements, tends to reduce demand for safe-haven assets like gold, but the impact was mitigated by falling Treasury yields and a weaker dollar, which make gold more attractive to investors. Conversely, the Fed's monetary policy, especially the prospect of interest rate hikes or cuts, has a direct impact on the opportunity cost of holding gold, which pays no interest. A more hawkish Fed (higher interest rates) tends to put downward pressure on gold, while a more dovish Fed (lower interest rates) tends to boost it.

Market impact

Interest Rates and Bonds: Treasury yields tend to fall in scenarios of reduced geopolitical risk aversion, as observed. This occurs because demand for safer assets decreases, and investors may seek returns elsewhere. A weaker-than-expected US CPI reading could reinforce expectations that the Fed will not raise rates, leading to a further drop in bond yields. Conversely, a stronger CPI report could push yields higher, pricing in a potential rate hike.

Dollar and FX: The US dollar tends to weaken during periods of easing geopolitical tensions, as its demand as a safe-haven currency diminishes. A weaker US CPI could also put downward pressure on the dollar, as it reduces the likelihood of monetary tightening by the Fed. A stronger CPI, however, could strengthen the dollar, given expectations of higher interest rates.

Equities: Stock markets tend to react positively to easing geopolitical tensions, as uncertainty decreases and risk sentiment improves. A weaker US CPI could be seen as positive for equities, as it signals less inflationary pressure and, consequently, less need for monetary tightening, which favors economic growth. A stronger CPI, on the other hand, could raise concerns about higher interest rates and negatively impact stocks.

Commodities: Gold, as a safe-haven commodity, tends to benefit from geopolitical uncertainties and a weaker dollar. The recent rebound was driven by geopolitical relief, but its future direction will heavily depend on the US CPI. A softer inflation report could boost gold, while a stronger report could put downward pressure on it, due to expectations of higher interest rates.

Brazil: In Brazil, easing global geopolitical tensions and a more stable US interest rate environment (or with a lower probability of hikes) tend to be positive. A weaker global dollar could alleviate depreciation pressure on the real. The expectation of a less hawkish Fed could reduce pressure on the Selic rate, giving the Copom more room. However, Brazil's internal and fiscal dynamics remain a predominant factor.

What to watch

The main event to monitor is the US Consumer Price Index (CPI) report, scheduled for release on Wednesday. A higher-than-expected core CPI reading could increase the probabilities of a Fed rate hike in October, putting downward pressure on gold. Conversely, a softer report could further ease rate hike concerns and provide another boost to the precious metal.

In addition to the CPI, other US economic data to watch include the Producer Price Index (PPI), Retail Sales, and weekly Jobless Claims figures, all on Thursday. Developments in US-Iran negotiations regarding the Strait of Hormuz will also continue to be a relevant geopolitical factor.

Scenarios

Base Case: The US CPI comes in line with expectations or slightly weaker, easing concerns about interest rate hikes and allowing gold to retain some of its recent gains, with potential for further upside. Geopolitical tensions remain contained.

Risk Scenario: The US CPI surprises with a stronger reading, raising expectations for a Fed rate hike. This would put downward pressure on gold, while Treasury yields and the dollar could strengthen. A resurgence of tensions between the US and Iran would also represent an upside risk for gold, but within a context of broader risk aversion.

Original source: ForexLive (InvestingLive). For information only, not investment advice.