Heightened Geopolitical Tension, Gold Awaits Direction from FOMC

N Faiszah Ishak

Commodity

Central Bank

Economic

Summary:

Some traders may stay on the sidelines before the upcoming two-day FOMC monetary policy meeting, scheduled to start this Tuesday.

Despite Israel's incursion into Gaza, the country's more measured approach has helped allay fears of a wider crisis in the Middle East, leading to a decrease in the safe-haven Gold price. However, the risk of further escalation in the Israel-Hamas conflict still exists, which, combined with uncertainty about China's economic recovery, is prompting some investors to buy Gold near the $1,990 region. While dip-buying appears, caution is advised before taking a position for any significant corrective decline.

The price of Gold (XAU/USD) initially dipped into the $1,990 range. Still, it rebounded and rose to a new daily high during the early part of the European session. However, it is still below the psychological level of $2,000. This is due to the expectation that the Federal Reserve (Fed) will keep the door open for one more rate hike in 2023 to bring inflation back to its 2% target. The hawkish outlook supports high US Treasury bond yields, which boosts demand for the US Dollar (USD) and may limit the growth of Gold, which does not yield any interest.

Some traders may stay on the sidelines before the upcoming two-day FOMC monetary policy meeting, scheduled to start this Tuesday. Meanwhile, the US economic calendar, which includes the release of the Chicago PMI and the Conference Board's Consumer Confidence Index, could potentially impact the price dynamics of the USD and give some momentum to the price of Gold. However, due to the current market conditions, aggressive traders should exercise caution and avoid making hasty decisions before the central bank event.

Gold price continues to attract safe-haven flows

The US economy remains strong, with inflation above the Fed's 2% target, allowing the central bank to maintain a hawkish stance.

Fed Chair Jerome Powell warned earlier this month that inflation remains high, and more rate increases are possible if the economy continues to outperform expectations.

Easing geopolitical tensions in the Middle East contributes to a slightly bearish tone around XAU/USD as investors move away from safe-haven assets.

Concerns over China's economy rise as Manufacturing PMI shrinks and growth in services sector slows in October.

The Federal Reserve is widely expected to maintain the current interest rates at a 22-year high during its two-day monetary policy meeting scheduled for October 31-November 1.

The Federal Reserve is expected to maintain the interest rate at 5.25%-5.50%, its highest in 22 years when it announces its decision on Wednesday.

Investors will be looking for cues regarding the future rate-hike path, which will influence the USD and provide fresh directional impetus to the price of Gold.

Gold is struggling to gain traction despite remaining below a peak reached last week despite a lack of follow-through selling.

The price of Gold is on track to rise by 8% this month, the most significant increase since November 2022. This is due to safe-haven demand resulting from the crisis in the Middle East.

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N Faiszah Ishak

Economic

Commodity

What is the definition of interest rates?

Financial institutions charge interest rates on loans to borrowers, which are paid as interest to savers and depositors. These rates are influenced by the base lending rates set by central banks in response to economic changes. Central banks' prime responsibility is to ensure price stability, usually targeting a core inflation rate of about 2%.

If inflation falls below the target, the central bank may cut base lending rates to promote lending and stimulate the economy. Conversely, if inflation rises above 2%, the central bank typically raises base lending rates to control inflation.

What is the relationship between interest rates and currencies?

Higher interest rates typically strengthen a country's currency, attracting global investment.

How do interest rates affect the price of Gold?

When interest rates rise, the value of Gold usually decreases. This is because investors are more likely to invest in interest-bearing assets or put their money in the bank instead of holding onto Gold. Additionally, high interest rates tend to strengthen the US dollar, lowering the price of Gold. As a result, Gold tends to perform better in a low-interest-rate environment.

What is the Federal Funds rate?

The Fed funds rate is when US banks lend to each other overnight. The Federal Reserve sets it at its FOMC meetings and is usually quoted as a range, such as 4.75% to 5.00%. However, the upper limit, in this case 5.00%, is the quoted figure. The CME FedWatch tool tracks market expectations for future Fed funds rates, influencing the behaviour of many financial markets in anticipation of future Federal Reserve monetary policy decisions.

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Alex

Economic

The Canadian economy appears to have entered a technical recession, with a minor contraction estimated in the third quarter, reinforcing the case for an end to interest-rate hikes.

Preliminary data suggested gross domestic product (GDP) was unchanged in September, Statistics Canada reported on Tuesday. The three straight months of flat output since July point to a decline of 0.1% annualised for the quarter, following a decrease of 0.2% over the period from April to June.

Although the third-quarter data will likely be revised, the pace is much slower than the 0.8% growth projected by the Bank of Canada earlier this month, and barely a pickup from the second quarter.

The Canadian dollar dipped about 0.1% after the release to C$1.3844 (RM4.75) per US dollar.

Statistics Canada also reported that GDP was flat in August, missing the median estimate for a gain of 0.1% in a Bloomberg survey of economists.

Tuesday's report supports the central bank's view that past interest-rate increases are working through the economy, slowing demand and allowing supply to catch up. With the economy now approaching balance, price pressures are expected to gradually moderate further, leaving more room for policymakers to stay on the sidelines.

Governor Tiff Macklem and his officials held borrowing costs at 5% for the second straight meeting last week, even as inflationary risks had increased. They expect economic growth to remain muted, averaging less than 1% over the next several quarters. The economy is projected to move into modest excess supply in the fourth quarter.

"The fact that the economy appears close to tipping into a mild recession already clearly reduces the likelihood of any further interest rate hikes, and will likely see financial markets pulling forward expectations for rate cuts which will weigh on the Canadian dollar," said Andrew Grantham, an economist at the Canadian Imperial Bank of Commerce, in a note to investors.

In September, decreases in mining, oil and gas extraction and utilities were offset by increases in construction and public sectors, while in August, higher interest rates, inflation, forest fires and droughts weighed on the economy.

Services sectors edged up 0.1% in August, and goods-producing industries contracted 0.2%.

Retail trade dropped 0.7%, continuing the downward trend that started at the beginning of this year. Lower activity at new car dealers drove the decline for a second straight month.

The manufacturing sector contracted 0.6%, with both non-durable and durable goods contributing to the decrease for a third month in a row.

Accommodation and food services declined 1.8% in August. Food service and drinking places declined 2.2%, more than offsetting the 2.1% increase in July. Activities at recreational camps and boarding houses were limited by the presence of wildfires in parts of the country, and the industry still hasn't fully recovered after the declines recorded in May and June.

The agriculture sector contracted 3.2% in August, its largest decline since August 2021. Crop production, excluding cannabis, declined 6.7%, in large part due to dry conditions in Western Canada.

Source: Bloomberg

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Justin

Central Bank

Forex

Data since September have been on the weak side

With the focus lately turned elsewhere, it has been a quiet month for the ΒοΕ, especially as its members continued to be less active when compared to their Fed and ECB counterparts. This comes after a difficult September BoE meeting, considering the 5-4 split vote in favour of a rate pause. Developments since then have been mixed as the late September upside surprise in the final GDP figure for the second quarter of 2023 was not followed by a plethora of stronger prints in other data releases.

More specifically, the property sector is a headache for the BoE as the various house price indices continue to show a contraction in prices. In addition, mortgage approvals remain in a downward trend and net lending is almost stagnant and potentially preparing for the first negative month-on-month print since August 2021. Also, retail sales continue to exhibit negative annual growth rates as consumer confidence shows further signs of deterioration.

Crucially, inflation edged higher in September but the same is not expected for October. This next inflation report will be released on November 15, and because of base effects, a strong deceleration in the annual figure is forecast. Governor Bailey has already been on the wires talking about this expectation, thus sending a strong signal to the hawks regarding Thursday’s meeting.

Doves Firmly in Control of BoE Meeting_1

Will it be an easier meeting for Governor Bailey?

Therefore, the decision seems easier this time around with the market assigning only a 2% probability for a 25bps rate move on Thursday. Having said that, the focus will be on the voting pattern and the overall rhetoric. In terms of the former, a 6-3 voting result in favour of another rate pause is expected; thus, we are in for a surprise if the four hawks that supported a rate hike in September do not shift their votes.

Additionally, the market will also be looking for the “further tightening in monetary policy would be required if there were evidence of more persistent inflationary pressures” comment that appeared in the last statement, in order to gauge if the BoE decided to tone down its hawkishness. To be fair, the overall BoE meeting is bound to be affected by what the Fed announces the previous night (Wednesday). If the Fed opts for a hawkish stance, there could be some inclination by Bailey et al to follow suit, without shocking the market. Such an outcome could result in the rate cut expectations, currently priced by mid-2024, to be pushed slightly out.

Quarterly forecasts on the menu as well

The meeting also entails the quarterly Monetary policy Report, which includes the Bank’s quarterly forecasts. The last set of these projections at the August meeting showed inflation dropping to 1.7% by end-2025 but with risks skewed towards a stronger figure. A confirmation of these forecasts and/or an even weaker outlook in the examined horizon could put to bed the prospects of further rate hikes and bring forward expectations for the first rate cut.

The pound is on the backfoot since August

The euro-pound pair has been experiencing an aggressive uptrend since the August lows as the euro bulls are trying to recover part of their sizeable losses that occurred during 2023. This move is somewhat surprising considering the ECB’s change of stance and the weak data releases seen in the euro area lately. Therefore, the pound could benefit from this week’s events. A hawkish BoE and/or a tighter voting result could allow the euro-pound pair to move lower, potentially overcoming the support set by the busy 0.8670-0.8720 area. On the flip side, a dovish meeting would keep the door open for the euro bulls to plot a course towards the 0.8794-0.8815 range.

Doves Firmly in Control of BoE Meeting_2

Source:XM

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ING

Economic

IP rebounds in September after two months of decline, but misses market expectations

Manufacturing output was surprisingly weak in Japan, with a mere 0.2% month-on-month sa rise in September after declines in the two previous months. Auto production led the rebound by improving global supply chains. We think strong auto sector performance will last for the time being, given the very tight global inventory conditions. But, with US sales expected to slow in the coming months, we may begin to see some cooldown of auto production from early next year. The survey of manufacturers showed that October production will likely rise 1.1%, and we think the recovery in manufacturing will strengthen entering the fourth quarter.

Retails sales dropped -0.1% MoM sa in September (vs revised 0.2% in August, market consensus)

Retail sales unexpectedly posted a loss for the first time in two months. Household machines (4.1%) gained for the third straight month, but other major outcomes were pretty weak. Motor vehicles (-0.8%), apparel (-7.2%), and general merchandise (-0.8%) all fell. We believe that this month's dip is still temporary, as the labour market continues with the same trend. But, as price tags have risen more rapidly than wage increases for an extended time, the downside risk of slowing household consumption is growing.

Labour market remained tight

Separately, jobs market data showed some improvement in September. The jobless rate edged down to 2.6% (vs 2.7% in August, market consensus 2.6%) and labour participation rate rose to 63.3% (vs 63.1% in August). In addition, the jobs to applications ratio was unchanged at 1.29 after trending down from the beginning of the year, and there are still more jobs unfilled in the market. We believe that a tight jobs market will likely support wage growth and consumption to some extent. The service sector will continue to lead the job markets on the back of solid tourism.

GDP outlook

As September IP and retail sales were softer than expected, we think that third-quarter GDP will be likely to post a small contraction. Manufacturing IP contracted -1.34% quarter-on-quarter sa in the third quarter (vs 1.4% in the second quarter), which should be the main drag for the growth. Retail sales improved in the same period with a 2.3% gain, but are estimated not to have caught up with high inflation.

We believe that a sharp correction in manufacturing will be the main reason for the contraction, and we have revised down our third-quarter GDP estimates from 0.0% QoQ sa to -0.2%. However, the current quarter growth should bounce back as resilience in auto manufacturing continues and an influx of foreign tourists supports service activity.

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Thomas

Economic

China's recent stimulus boost stoked some optimism about the economy's recovery in the coming quarters, but economists are keeping their 2024 growth forecasts steady for now to assess how the measures will play out.

The world's second-largest economy is projected to grow 4.5% next year, according to the median estimate in a Bloomberg survey of 48 economists conducted after last week's official announcement of the additional stimulus. The result was unchanged from an earlier poll. The number of respondents is smaller than the usual pool due to a shorter period for submissions.

Meanwhile, the forecast for expansion this year is upgraded to 5.2%, 20 basis points higher than both the prior survey and Beijing's official target of about 5%, after China released better-than-expected data for the third quarter.

China increased its headline deficit last week to the largest in three decades, and unveiled a one trillion yuan (US$137 billion or RM650.91 billion) sovereign debt package for construction projects. While the rare moves signalled policymakers want to prevent a sharp growth slowdown in 2024, the stimulus remained measured and will take time to show effects.

"Beijing's rare budget expansion marks a critical step in reflation," Morgan Stanley economists including Robin Xing wrote in a note last week. "We expect growth and inflation to improve but in a subpar fashion. More stimulus and reforms are likely needed and exiting deflation could be a two-year journey."

Economists Stick to 2024 China Outlook While Assessing Stimulus_1

Morgan Stanley upgraded its China growth forecast to 5.1% for this year from as low as 4.8% previously after the third-quarter gross domestic product data, and kept unchanged the projection for 2024 at 4.2%. The bank held both positions after the stimulus was announced.

The People's Bank of China may cut the amount of cash lenders must hold as reserves, known as the reserve requirement ratio, in the coming weeks to help fund government bond sales.

Interbank liquidity already tightened in recent months due to a surge in local government bond supply. Cash conditions are expected to remain strained in the coming months, as more government notes including the additional sovereign debt hit the market.

Economists now expect the central bank to cut the reserve requirement ratio by 25 basis points by year end. That's earlier than the prediction for such a move in the first quarter of 2024, in the previous survey.

Economists Stick to 2024 China Outlook While Assessing Stimulus_2

Official data on Tuesday showing a contraction in China's manufacturing sector in October underscores just how fragile the economic recovery is, with calls for more policy support growing.

Property remains the biggest threat to the economic outlook, while mounting local government debt is limiting authorities' ability to spur investment. The sustainability of a consumption rebound is in question amid persisting deflationary pressures and a sluggish job market.

"Beijing is taking a firm stance on supporting growth, as seen with the recent issuance of one trillion yuan in sovereign bonds," HSBC Global Research economists including Jing Liu wrote in a Monday note. "This should have a positive effect for growth, though the effect may be more back-loaded into next year."

HSBC has yet to make any revisions to its late-September forecasts for the Chinese economy to grow 4.9% this year and 4.6% the next.

"Notwithstanding the short-term cyclical improvement, the Chinese economy will continue to be faced for some time with fierce headwinds from the property sector and related debt issues, from the global growth slowdown and from ongoing tensions with the US, European Union, and the West," said Arjen van Dijkhuizen, a senior economist at ABN Amro. The bank predicts China's growth to be 5.3% this year and 4.7% in 2024.

"Coupled with Beijing's policy shift away from growth maximisation towards goals related to national security and self-sufficiency, we expect China's structural slowdown to continue and annual growth to fall below 5% from 2024 onwards," he said, also noting longer-term challenges including demographics and climate change.

Other key highlights of the survey

Economists delay their projection of a 10 basis-point cut in China's one and five-year loan prime rates by one quarter, to the January-March period in 2024
The central bank is expected to trim the rate of its one-year medium term lending facility by five basis points before year end, compared with an earlier forecast of a 10 basis-point reduction
Producer prices are expected to contract 2.1% for the last quarter of this year, a slight improvement from an estimate of a 2.4% decline in the prior survey
Exports are likely to rise 0.1% in the fourth quarter, compared with an estimated 2.7% drop in the last poll

Imports are seen declining 3% in the period, slower than the previous projection of -3.1%

Source: Bloomberg

To stay updated on all economic events of today, please check out our Economic calendar

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Central Bank

Forex

Data since September have been on the weak side

Will it be an easier meeting for Governor Bailey?

Additionally, the market will also be looking for the "further tightening in monetary policy would be required if there were evidence of more persistent inflationary pressures" comment that appeared in the last statement, in order to gauge if the BoE decided to tone down its hawkishness. To be fair, the overall BoE meeting is bound to be affected by what the Fed announces the previous night (Wednesday). If the Fed opts for a hawkish stance, there could be some inclination by Bailey et al to follow suit, without shocking the market. Such an outcome could result in the rate cut expectations, currently priced by mid-2024, to be pushed slightly out.

Quarterly forecasts on the menu as well

The meeting also entails the quarterly Monetary policy Report, which includes the Bank's quarterly forecasts. The last set of these projections at the August meeting showed inflation dropping to 1.7% by end-2025 but with risks skewed towards a stronger figure. A confirmation of these forecasts and/or an even weaker outlook in the examined horizon could put to bed the prospects of further rate hikes and bring forward expectations for the first rate cut.

The pound is on the backfoot since August

The euro-pound pair has been experiencing an aggressive uptrend since the August lows as the euro bulls are trying to recover part of their sizeable losses that occurred during 2023. This move is somewhat surprising considering the ECB's change of stance and the weak data releases seen in the euro area lately. Therefore, the pound could benefit from this week's events. A hawkish BoE and/or a tighter voting result could allow the euro-pound pair to move lower, potentially overcoming the support set by the busy 0.8670-0.8720 area. On the flip side, a dovish meeting would keep the door open for the euro bulls to plot a course towards the 0.8794-0.8815 range. Doves Are Firmly in Control of BOE Meeting_2