Gold Rises as Treasury Yields Ease and Dollar Pauses, But Vulnerability Persists

What happened

Spot gold rose towards $4,180 an ounce during Asian trading on Friday, extending its recovery from a two-month low hit on Wednesday. This rally was primarily driven by a second consecutive session of decline in US Treasury yields, after the 10-year Treasury yield reached a 24-year high on Wednesday. Additionally, the US dollar's rally paused, contributing to support for the precious metal. St. Louis Fed President Alberto Musalem stated that further rate hikes will be needed to bring inflation back to the 2% target, although he did not specify actions for the upcoming meeting. According to CME's FedWatch tool, traders are pricing an 18% chance of a rate hike in October and 82% by December. On the geopolitical front, President Donald Trump declared that the US would not attack Iran before November's midterm elections and described talks with Tehran as productive, which reduced the short-term risk premium for gold.

Why it matters

Gold's rebound is closely tied to the pullback in Treasury yields, which reduces the opportunity cost of holding the metal, as it pays no interest. A weaker dollar also makes dollar-priced gold cheaper for buyers using other currencies. However, the underlying macroeconomic backdrop remains challenging. The expectation of further monetary tightening by the Federal Reserve, with inflation being sustained by high oil prices due to Middle East supply risks, limits gold's upside potential. Higher interest rates reduce gold's appeal relative to yielding assets. Trump's statement on Iran temporarily trimmed gold's safe-haven premium, indicating that geopolitics offers less support to the metal than before.

Market impact

• Interest rates and bonds: US Treasury yields tend to fall in the short term, easing pressure on global borrowing costs. However, the prospect of further Fed tightening and strong economic data could quickly reverse this trend, pushing yields back up.
• Dollar and FX: The pause in the dollar's rally tends to ease pressure on other currencies. However, the expectation of higher US interest rates could resume the dollar's strength, especially if the Fed signals a more aggressive path.
• Equities: The decline in Treasury yields may offer temporary relief for equity markets, especially for growth companies, by reducing the cost of capital. However, persistent inflation concerns and the possibility of further monetary tightening could limit gains and generate volatility.
• Commodities: Gold tends to benefit from falling Treasury yields and a pausing dollar, but its appreciation is limited by expectations of higher interest rates and oil-driven inflation. Oil prices, in turn, remain elevated due to Middle East supply risks, keeping inflation concerns alive.
• Brazil: The drop in Treasury yields and the dollar's pause may provide momentary relief for the Brazilian real and the local interest rate market, allowing room for the Copom to consider the pace of Selic cuts. However, a resumption of US interest rate hikes and dollar appreciation could once again pressure the exchange rate and future interest rates in Brazil.

What to watch

Investors should closely monitor upcoming US economic data, which will provide crucial signals ahead of the Fed's October meeting. The direction of Treasury yields is likely to remain the main driver for gold in the near term. Additionally, any further comments from Fed officials on monetary policy and the evolution of oil prices and geopolitical risks in the Middle East will be important.

Scenarios

Base Case: Treasury yields remain volatile, with gold finding limited support from the dollar's pause but under pressure from expectations of further Fed tightening. Inflation persists but without significant acceleration. Risk Scenario: Strong US economic data or more hawkish Fed commentary leads to a resumption of the Treasury sell-off, with yields rising and the dollar strengthening, pushing gold to new lows. Geopolitical risks may escalate, but the impact on gold is mitigated by monetary policy.

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