Threat of Rising Inflation
The week ahead may feature some market fireworks as investors get ready for the latest FOMC meeting and statement. No policy changes are expected from the central bank this week, however, markets will closely scrutinize its statements following the decision for any changes in language or outlook.
The threat of rising inflation has become an increasingly key topic for markets in recent months. Investors will pay close attention to the Fed this week, looking for any clues as to potential policy changes down the road or rising concern over inflation. Any hints of the Fed beginning to tighten policy could send both stocks and the gold market sharply lower. Markets appear to have gotten quite used to easy money and any removal of the punchbowl by the Fed could put a major dent in investor psychology.
In addition to the Fed this week, concerns and optimism over the Covid-19 pandemic may determine market direction. There has been growing optimism in recent weeks as economies heal from the effects of the virus. Several locations have, however, become a major source for concern as the virus continues to spread.The country of India, for example, has become a major area of concern as it grapples with the spread of the virus. If the situation in India and other locations worsens, it may also keep investors on the sidelines or even hitting the sell button. It is unclear how the yellow metal would react to such a scenario, although it seems the metal could climb as risk appetite dwindles.
The Fed and its easy policies have fueled more talk of a market bubble that will soon pop. Some analysts have suggested the next major breakdown is likely to occur this year or next. The biggest question appears to be whether it will be of the 30% or 80% variety. With stock valuations now double GDP, the market has reached an arguably overvalued extreme. At some point, sooner or later, that bubble will pop and valuations could come down sharply. In that event, the Fed is likely to try to respond with more of the same. The problem, however, is that the Fed already has the gas pedal to the floor. It is tough to lower interest rates enough to affect the economy when rates are already at zero. The central bank could elect to increase its QE operations, but how much more the Fed can do without destroying any remaining faith in the U.S. Treasury market is unclear. The situation will not be put under control easily, and the sell-off could occur in both stocks and bonds simultaneously. Such a scenario would turn a major sell-off into a full blown meltdown, leaving investors looking for alternative asset classes in which to stash capital. This could be a major catalyst for sharply higher gold prices and could lead to a rapid move for the metal to $5000, $10,000 or beyond.
The bulls have been fighting to retake control of the market on the daily chart. The $1800 level seems to still be a key resistance area that must be taken out on a closing basis if gold is to continue its ascent. The bears will likely target the $1700 level on the downside to gain further momentum.