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Inflation hints at potential moves for Gold and USD

Inflation hints at potential moves for Gold and USD

Rising inflation has been the question many analysts, investors, and traders want answers to. Fortunately, these answers may come soon as Federal Reserve Chairman Jerome Powell is set to take the stage (virtually, of course) to address the future of US Monetary Policy post Coronavirus and, hopefully, answer the myriad of questions regarding the Fed's stance on inflation.​

Inflation rate in the United States over the past 10 years

It is the Federal Reserve's mandate to have inflation hover around 2%. However, with low inflation rates before the pandemic, Jerome Powell runs the risk of deflation due to US citizens not being employed.

Analysts predict that the Fed will release a new tool to increase inflation for a more extended period, increasing growth and pricing power. Rick Rieder, BlackRock's Global Chief Investment Officer of Fixed Income, stated that "the rate markets are anticipating the Fed is going to be dovish and willing to withstand inflation being higher for a more extended period.

Both the US Dollar Index and Gold gearing up for some potential moves on Inflation Policy

Currently, the Dollar Index sits just under 93 alongside Gold sitting at $1,943 an ounce. Both are suspectable to change in policies regarding inflation, with both gearing up for a move that would see Gold strengthen and the US Dollar weaken even further if Jerome Powell hints at pumping up inflation.

What's the link between Gold and inflation?

You always hear people say, "Gold is a safe haven" However, you may not know why, only that when stocks are selling off, Gold is picking up. What is one of the "haven" attributes that people state as a reason for buying gold?

As you can guess by the article – Gold and inflation go hand in hand. That is, as inflation increases, so do, theoretically, the price of Gold. We could go into the nitty-gritty side of things, take out our Econ 101 books, and talk about M1, M2, and M3 money supply, etc. However, what it boils down to is the supply and demand of money versus the supply and demand of Gold.

We all know that the Federal Reserve has been printing money as a drastic attempt to curve the Coronavirus's economic effects on the financial markets. However, this increase in the supply of money risks the devaluation of the US currency. As supply and demand states, an increase in supply, Ceteris Paribus, decrease the price. In this case, an increase in supply implies an increase in spending and demand for goods and services, incentivizing businesses to increase their prices – inflation!

If the price of goods and services increases, one US dollar buys less, therefore losing its value.

Gold is historically resilient against inflation

However, the supply of Gold is relatively set year over year, alleviating the problem money has as there is no central bank increasing/decreasing the supply. Since inflation does not affect Gold's value, the logic holds that people would instead hold Gold since it will not lose its value through periods of inflation, unlike the US dollar.

Inflation also affects many US dollar-denominated bonds. Bondholders get paid a set amount of interest. However, when inflation rises, the real yield the bondholders get paid gets diminished. Real yield is calculated by the nominal interest rate subtracting the inflation rate. In a 0% interest rate environment alongside rising inflation, sees real yields drop into the negatives. Negative real yields push investors away from the US dollar and into other positive or even neutral assets like you guessed it... Gold.

So why inflation?

With all these consequences regarding inflation – why is Jerome Powell insistent on maintaining their 2% guidance? Inflation is essentially a bi-product of stimulus that the Central bank and the government implement. Essentially, the government and central banks' goal is to get the economy moving by increasing employment and increasing the cash households have to spend throughout the economy. An increase in demand for goods and services incentives businesses to increase their prices, hence inflation.

However, there is a more critical reason why Jerome Powell wants to try and spur inflation – its that he does not want the opposite, deflation. Deflation is when prices of goods and services decrease. This is a destructive cycle for an economy to enter into as consumers get into the mindset – "Oh, prices are going to get cheaper in the future? I will just wait then." – However, that is a whole other topic.

For now, all eyes on the head of the money printer, the US Dollar, and Gold.

Anish Lal, an analyst here at BlackBull Markets did some excellent analysis on the GBP/USD ahead of today's speech. You can watch it here.