Gold has witnessed a sharp correction in recent days as market players softened risks related to Russia-Ukraine, reducing the appeal of a safe haven, while a correction in commodity prices also reduced demand as an inflation hedge.

The recent correction was amid positioning for the US Fed’s decision.

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Madhavi Mehta – Associate Vice President – Commodity Research at Kotak Securities decodes where the gold price is headed and the impact of the US Fed rate hike:

Gold briefly fell below the key $1900/oz level just before the US Fed decision, but witnessed a sharp recovery after the decision and moved closer to the USD 1940/oz level.

It can be seen as a general case of selling the rumor, but the fact is that market players are also assessing the future stance of the Fed given the uncertainty about both inflation and economic growth.

The US Federal Reserve decided to raise its key lending rate from 0-0.25% to 0.25-0.5%, the first hike since the start of the pandemic, in line with market expectations.

Earlier this month, market players expected a sharper 0.5% rate hike, but lowered expectations as tensions between Russia and Ukraine posed a challenge to global economic activity.

The Fed’s rate hike decision showed that the central bank wants to take a gradual approach amid ongoing challenges.

The US Fed stressed that the impact of the conflict between Russia and Ukraine on the US economy remains highly uncertain, but could exert upward pressure on inflation in the near term and weigh on economic activity.

The Fed’s economic forecasts also show a mixed picture. The Fed has forecast six more rate hikes by the end of 2022, bringing the key lending rate to 1.75-2%.

This is broadly in line with market expectations, as the central bank remains determined to bring inflation under control. The Fed has also raised inflation forecasts, highlighting lingering concerns about mounting price pressures.

The Fed raised its inflation forecast for 2022 from 2.6% to 4.3%. The Fed has also raised its inflation forecast for the next two years, indicating that price pressures may not come under control soon. Added to this is the uncertainty about the impact of the fighting between Russia and Ukraine on commodity and energy prices.

At the conference after the meeting, Fed Chair Jerome Powell justified the rate hike by stating that the US economy is strong enough to handle monetary tightening.

However, the Fed’s economic projection shows a bleak outlook. The Fed has cut its 2022 GDP growth estimate from 4% to 2.8%, a sharp revision that reflects mounting uncertainty from geopolitical risks and the withdrawal of pandemic-era stimulus.

The Fed has entered the monetary tightening cycle because it wants to send a signal that it is working to bring inflation under control.

The US Fed has six more scheduled meetings this year, and forecasts indicate there will be one increase of 25 basis points per meeting.

The Fed has set the course and will measure inflation against growth at each meeting before making a decision. Growth prospects will be tested unless the conflict between Russia and Ukraine is resolved and sanctions against Russia are lifted. Rising borrowing costs and tighter liquidity conditions may also pose a challenge to economic activity.

The Fed’s monetary tightening is negative for gold as higher interest rates increase the opportunity cost of holding the metal. Gold, however, has managed to hold its own amid expectations that the central bank will take a gradual approach to weigh growth against inflation.

In addition, mounting inflationary pressures and fears of supply shocks have increased the appeal of gold as an inflation hedge.

(Disclaimer: The opinions/suggestions/advice expressed here in this article are those of investment experts only. Zee Business encourages its readers to consult their investment advisors before making any financial decision.)

This post Gold pauses after US Fed decision; higher interest rates are negative for yellow metal, says Madhavi Mehta of Kotak Securities

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