Markets Speculate on Hawkish FOMC Minutes, Weighing on Gold

Markets are pricing in more hawkishness from the Fed ahead of the release of the minutes from the last meeting, which saw a pivot in focus towards inflation under the new Fed Chair.

Key Points Moving the Market

• Markets are looking for more details on what Warsh's hawkish pivot actually means and whether the minutes will reflect his recent tone.
• Odds of a rate hike by the end of the year have been remarkably steady despite recent data and given the new data-dependent Fed focus.
• Given market bias towards hawkishness, a dovish surprise is likely to be a bigger surprise and boost gold prices.

A Hawkish Trump Appointee at the Fed?

Gold prices are under pressure ahead of the release of the FOMC minutes on Wednesday, as traders apparently expect the recent pivot towards hawkishness to be affirmed in the record of the last meeting. Kevin Warsh had been appointed by the notoriously dovish US President Donald Trump but came out swinging against inflation after his first meeting last month. He later doubled down on those comments at the ECB's Forum in Sintra, arguing that he believes the market underestimates his willingness to fight inflation. This is an odd pivot for the Fed, after Trump railed against former Chair Jerome Powell (under whom rates were cut six times over the last two years) for being too hawkish. Nevertheless, markets seem to be interpreting Warsh's comments as suggesting interest rates will go up, considering that inflation has not returned to target since the pandemic surge.

The minutes will be pivotal for the market, either affirming or revising its projection of 80% odds of a rate hike by the end of the year. However, the issue might have more to do with the Fed's credibility. An important part of central bank theory holds that inflation tends to move with market expectations of the central bank's actions. The role of the central bank is to "anchor" inflation expectations by signalling that it will raise or lower interest rates to control inflation. Providing interest rate projections can help reassure market actors that the Fed will "credibly" fight inflation. But after months of pressure from the White House on the Fed, Warsh might be worried that he's perceived as dovish, which could allow inflation to rise. As a first-time Fed Chair, he's likely to make "mistakes" in communication, intending to convey something to the markets that traders interpret as a different signal. Traders might be getting a very hawkish signal from Warsh that won't be reflected in the minutes, for example, which could lead to a dovish surprise.

Weaker Data But Odds Unchanged

Notably, after the poor June jobs report, the odds of a rate hike by the end of the year didn't change. In fact, they haven't changed even as crude prices fall, relieving inflationary pressure. Of course, December is still some time away, and with Trump in the White House, many things could happen in the next six months. Markets are still pricing in a hold for the July meeting, the most relevant for the dollar and gold at the moment. Traders are still adjusting to Warsh's more simplified, data-dependent tone, which increases the relevance of the minutes, as they provide additional insight into FOMC members' thinking. They will be closely watching to see just how much Warsh's inflation-first campaign is echoed by the rest of the committee and how many are worried about the jobs market in light of the recent NFP numbers. A hawkish surprise is unlikely, but a dovish surprise could push gold higher.

Gold Fails to Hold Median VWAP as Support

The price of gold has failed to cross above the median VWAP, leading to a pullback from $4200/oz. With the $4K ahead as the next major support, only a rejection at the round level would suggest a potential continuation towards the upper VWAP near $4,300. On the other hand, if the psychological support and the lower VWAP at $3950 give way to a hawkish interpretation, the recent RSI divergence would be invalidated, and the door opened to $3870.

Source: SpreadEx, Gold, Daily Chart