It is not one, or two, but three interest rate hikes that the US Federal Reserve has signalled for 2022 at its recently held meeting. This is a sentiment dampener for gold, a non-interest bearing asset class. The US Fed assumed inflationary pressures as transitory earlier. “However, now they seem to prioritize reining in high inflation and have indicated a quick pace of tapering monthly bond purchases, which shall pave the way for rate hikes earlier than previously anticipated in 2022. With the Fed switching gear and the era of easy money coming to an end, this would not be a favourable backdrop for gold prices," said Sugandha Sachdeva, vice-president of commodity and currency research, Religare Broking Ltd.
Simply put, rising rates will cap the gains in the yellow metal as they increase the opportunity cost of holding gold, said Sachdeva.
Debajit Saha, the lead metals analyst at Refinitiv, a London Stock Exchange Group business, said, “When the US Fed decides to increase interest rates, there is a certain possibility that gold might slightly lose its sheen as an investment option. Investors might also start to liquidate their holdings in exchange-traded funds (ETFs) at a higher level."
Overall, the outlook for gold prices is looking a tad bearish in 2022. According to Saha, key levels for the gold prices could be at $1,568 per ounce at low and $1,876 per ounce on the high.
Currently, domestic gold prices are at around ₹48,000 per 10 grams. The yellow metal is trading at nearly $1,800/ounce in the international market. So far in this calendar year, gold has given negative returns of 4% in local currency terms.
In comparison, the key benchmark equity index, Nifty 50, has gained 21%. One reason for gold’s muted performance in 2021 seems to be that investors have adjusted their expectations regarding the Fed and other central banks.
Recall that gold prices surged to an all-time high in 2020 as global central banks reduced interest rates to historic lows coupled with ample stimulus in the backdrop of a raging coronavirus crisis.
Gold demand, especially as an investment option, was robust amid the pandemic due to its safe-haven status. In 2021, prices saw some moderation on receding risks of the pandemic and rising pace of vaccinations.
For a large part of 2021, interest rates remained unchanged. However, some emerging market central banks such as Brazil and China have recently raised their key lending rates. The Bank of England was the first among developed economies to raise interest rates by 15 basis points in December. One basis point is 0.01%.
Meanwhile, a fallout of interest rate hikes would also be felt on the dollar and treasury yields, both of which have an inverse relationship with gold prices. The prospects of a recovering US economy and thereby rising interest rates would mean a strong dollar, which does not bode well for gold bulls.
Even though interest rate hikes by the US Fed would be gradual, an impact is already seen in the bond market, with yields rising in India and the US.
On the other hand, a scenario of the Omicron variant becoming a more serious health risk than currently anticipated could help gold gain its sheen back. According to Warren Patterson, head of commodities strategy at ING, “Precious metals are likely to struggle the most over 2022. The only scenario where we see further upside for gold prices is if we see central banks doing a U-turn on tightening. A potential catalyst for this would be further severe waves of covid-19."
