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The gold market is drifting a bit lower in early afternoon action on Wednesday as the dollar moves higher. The midweek dollar rally is keeping the gold bulls at bay and could have a lasting effect on the market if it continues to ascend. The dollar is likely taking its cues from the uncertainty in the marketplace currently as well as the aggressive nature of recent Federal Reserve interest rate hikes. The dollar may keep moving higher and strengthening as long as the Fed maintains its recent aggressive position and rhetoric. Should the Fed elect to pause or reverse course, however, the dollar could quickly see much of the air let out of its balloon, possibly benefitting gold in the process.

There has been increasing discussion recently about the Fed possibly going too far and putting the economy into recession. Following the central bank’s recent surprise 75-point rate hike, the concerns over an overly aggressive Fed are likely to increase substantially. The Fed will almost certainly raise rates by another 75-basis points at its next meeting, and could continue to do so at additional meetings beyond the month. The Fed has said that it intends to combat inflation using all of the tools within its arsenal, and raising interest rates significantly is probably the simplest way the central bank can slow price pressures. The question is:will it be enough?

Some analysts have already suggested that the Fed will be unable to raise rates enough to put a dent into inflation. They have further stated that to do so would require interest rates at Volcker-era levels. Markets seem to be nervous already about rates going to 3%. How would they react to an interest rate at or approaching 20%? It would likely be messy, so messy in fact that the Fed would almost certainly not even entertain taking rates anywhere near that level. As the recession risks increase along with higher rates, the Fed could elect to take a pause or even reverse course and start lowering rates once again to boost the economy. Whatever the central bank decides to do, it is likely to involve a period of significant pain.

Fed Chairman Jerome Powell recently stated that he believes inflation represents the most serious economic threat. If price stability is not soon restored, it could lead to a permanent transition from low to high inflation. Powell seemingly recognizes that the clock is also ticking to get inflation under control. The longer price pressures remain, the greater the risk of inflation becoming entrenched. Powell’s commentary seemed to suggest that the Fed will stay the course and will keep raising rates as it deems necessary. While acknowledging the recession and other risks in doing so, Powell believes that allowing inflation to become entrenched would be the worst case scenario. Investors may want to prepare themselves for a recession, it seems, as the Fed could very well be sending the economy there in the months ahead.