Gold trading reminder: The Federal Reserve unexpectedly cut interest rates by 50 basis points, Powell "turned the tide", and the price of gold hit a record high before plummeting by nearly $5

Spot gold fluctuated slightly higher in early Asian trading on Wednesday (September 18), and is currently trading around $2,574.03 per ounce. Gold prices fell slightly from their historical highs in the previous trading day, closing at $2,569.35 per ounce, as the monthly rate of U.S. retail sales in August was stronger than market expectations, the U.S. dollar and U.S. Treasury yields rebounded, and some traders took profits on long orders in preparation for the Fed's possible rate cut decision this week.

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The unexpected growth in U.S. retail sales in August, and the decline in auto dealer sales was overshadowed by strong online shopping, indicating that the U.S. economy remained robust for most of the third quarter, which put pressure on safe-haven gold.

The U.S. Commerce Department's report on Tuesday showed that retail sales in July were slightly stronger than initially estimated. Coupled with the decline in the unemployment rate in August, financial markets have reduced bets on the Fed's 50 basis point rate cut on Wednesday. Fed officials began a two-day policy meeting on Tuesday.

After the data, the Atlanta Fed raised its forecast for third-quarter gross domestic product growth to an annualized rate of 3.0% from 2.5%. The economy grew 3.0% in the second quarter.

“Fed officials seemed to have no reason to cut rates by 50 basis points out of the gate because whatever pressures there were in the labor market were not translating into weaker demand in the economy,” said Christopher Rupkey, chief economist at FWDBONDS. “If the economy was on the verge of a recession, consumers certainly didn’t see it.”

The U.S. Census Bureau said retail sales rose 0.1% in August from the previous month, after July’s reading was revised up to 1.1% and the previous reading was 1.0%. Economists had expected retail sales to fall 0.2% in August, with specific forecasts ranging from a decline of 0.6% to an increase of 0.6%. The retail sales data is mainly composed of goods and is not adjusted for inflation. Retail sales rose 2.1% in August from a year ago.

The CME FedWatch Tool shows that financial markets are pricing in about a 63% chance of a 50 basis point rate cut on Wednesday, down from 67% before the retail sales data was released. The probability of a 25 basis point rate cut is about 37%, up from 33% previously.

Financial markets are pricing in a higher chance of more aggressive action from the Fed. This would be the first rate cut by the Fed since 2020.

"Gold is trading lower today as yields across all maturities have risen as some are concerned that if the Fed cuts by 25 basis points tomorrow, there may be less incentive to buy gold," said Bart Melek, head of commodity strategy at TD Securities.

Goldman Sachs said on Monday that based on the bank's economists' base case assumption that the Fed cuts by 25 basis points on Wednesday, they see some tactical downside for gold prices and reiterated their long gold trade recommendation and target price of $2,700 an ounce by early 2025.

Most economists expect the Fed to cut interest rates by 25 basis points on Wednesday, and they believe that economic difficulties are not enough to justify the 50 basis point rate cut expected by financial markets.

Core retail sales, which exclude autos, gasoline, building materials and food services, rose 0.3% in August from the previous month, after a revised 0.4% increase in July and a 0.3% increase in the previous month.

Core retail sales best reflect the consumer spending component of gross domestic product (GDP). Economists estimate that core retail sales, adjusted for inflation, rose 0.1% in August, which puts consumer spending on track to grow at an annual rate of about 3.5% this quarter.

Other data released on Tuesday were also optimistic, with manufacturing output rebounding sharply in August but the July reading revised down.

The Fed said in its report that manufacturing output rose 0.9% in August from the previous month, due to a surge in motor vehicle output, while economists had previously forecast an increase of 0.3%. The July reading was revised down to a 0.7% decrease, compared with a 0.3% decrease in the previous month.

Corporate inventories also rose slightly more than expected in July, which could boost GDP growth this quarter.

"Manufacturing is nowhere near the usual level of weakness that you would see if the U.S. economy were in a recession," said Conrad DeQuadros, senior economic adviser at Brean Capital.

The dollar rose against most major currencies on Tuesday, with the dollar index closing at 101.02, up about 0.35%, after better-than-expected retail sales data seemed to support a less aggressive stance from the Federal Reserve, which is widely expected to announce its first rate cut in more than four years. The Fed last cut rates in March 2020 during the coronavirus pandemic.

"I think all markets are currently captive to the FOMC decision on Wednesday," said Marvin Loh, senior global market strategist at State Street.

Axel Merk, president and chief investment officer of Merk Investments, said: "Overall, the market is digesting the expectation of multiple rate cuts in the coming months, and there are some voices suggesting that the market may be a little ahead of the times."

It should be reminded that the market has partially digested the expectation of the Fed's 50 basis point rate cut on Wednesday, so whether it is a 25 basis point or 50 basis point cut, investors need to beware of the emergence of the "shoe landing" market, when a large number of long orders may take the opportunity to take profits, thereby dragging down the trend of gold prices. Similar market conditions have occurred many times in history: before the Fed cut interest rates, gold prices continued to rise supported by the expectation of rate cuts, but after the Fed actually cut interest rates, gold prices fluctuated and weakened.

From a technical perspective, at the daily level, gold prices have appeared near the historical highs. K-line combinations similar to the "evening star" are a peak signal. If it cannot quickly set a new high, it means that the gold price has peaked in the short term, and the market will usher in a wave of adjustments in the future. If the correction is strong, it may even usher in a wave of declines. Investors need to be vigilant. Pay attention to the support near 2550 and the August 20 high of 2531.58 below; pay attention to the resistance of 2580 and 2600 above.

The uncertainty of the Fed's rate cut prospects raises questions about when QT will end

The magnitude of the first rate cut expected by the Federal Reserve on Wednesday remains uncertain, which has sparked discussions about whether the central bank may accelerate the end of its balance sheet reduction.

If policymakers do choose a larger rate cut and indicate concerns about the economic outlook, the timeline for further quantitative tightening (QT) may be greatly shortened.

Quantitative tightening is basically seen as a liquidity management tool, which is significantly different from the Fed's interest rate policy that focuses on curbing inflation without causing too much pain to the labor market. But a larger rate cut by the Fed may be seen as contradictory to liquidity tightening, depending on the reasons behind the rate cut.

The imminent end of quantitative tightening would mean a major shift in the outlook for the central bank's balance sheet. A July survey of large banks by the New York Fed found that they expected quantitative tightening to end in April next year, while Fed officials have hinted that they see a lot of room to continue quantitative tightening.

"If they cut rates 50 basis points, I think the decision on the balance sheet is going to get a lot trickier," said Patricia Zobel, a former manager of the New York Fed's monetary policy implementation group and now head of macroeconomic research and market strategy at Guggenheim Investments.

Zobel said if the rate cuts are larger and there are economic concerns, then "we do have a chance" to end quantitative tightening sooner. The former Fed official currently expects the Fed to cut rates by 0.25 percentage point and that quantitative tightening will continue on its current trajectory.

The Fed currently sets a target range for the federal funds rate of 5.25% to 5.50%.

Matthew Luzzetti, an economist at Deutsche Bank, said a big rate cut on Wednesday and hinting at more aggressive easing in its latest forecasts would mean "a conflict between rate cuts and continuing to reduce the balance sheet, and in this environment the Fed may not want to send that mixed signal from its policy tools."

Meanwhile, Bank of America analysts believe a 0.5 percentage point rate cut to boost the economy would lead to a quick end to quantitative tightening.

The heightened uncertainty over rate cuts comes down to whether the Fed will bring borrowing costs back to normal levels as inflation falls; some argue that one or two big rate cuts would be OK along those lines. But the more prominent risk to the QT outlook is whether rate policy changes are driven by heightened concerns about a stagnant job market.

Quantitative tightening is now just over two years old. The Fed more than doubled its balance sheet to as much as $9 trillion in 2022 through purchases of Treasurys and mortgage-backed securities to calm market turmoil and boost the economy.

Quantitative tightening began as the Fed shifted to raising rates to curb inflation and officials concluded that excessive easing was no longer appropriate. So far, the Fed has reduced its holdings by about $1.8 trillion and in May cut its monthly reduction target from $95 billion to a current maximum of $60 billion.

The Fed seeks to keep enough liquidity in the financial system to allow for normal short-term interest rate fluctuations and maintain a tight grip on the federal funds rate. So far, discussions about ending quantitative tightening have focused on finding the optimal level of liquidity.

William Dudley, who served as president of the New York Fed until his retirement in 2018, said the Fed "will not adjust QT" unless the Fed believes they have transitioned from ample reserves to adequate reserves. "They don't know exactly when they will get there, but they are fairly confident that they are not there yet," he said.

So far, quantitative tightening has been a relatively quiet event. New York Fed President John Williams said quantitative tightening is no longer a driver of market moves because investors have "priced it in" to long-term borrowing costs.

Meanwhile, James Bullard, former president of the St. Louis Fed and current dean of Purdue University's business school, noted that quantitative tightening and interest rate policy are consistent, at least for now, and can remain that way even with rate cuts.

Bullard said it would be time to consider ending quantitative tightening when the federal funds rate approaches neutrality in order to better coordinate the two policy tools. Analysts at research firm LH Meyer believe that a move to cut the federal funds rate to 3% or lower would itself be a trigger to end quantitative tightening.