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Gold plunges, as strong inflation boosts hawkish case for 2016 rate hike

CommoditiesFeb 26, 2016 01:06PM ET
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Gold plummeted by more than $18 an ounce on Friday to close below $1,225 -- Gold fell sharply on Friday after the Federal Reserve's preferred gauge for inflation rose by its highest annual percentage in more than three years, augmenting hawkish sentiments for accelerated normalization in the U.S. central bank's first tightening cycle in nearly a decade.

On the Comex division of the New York Mercantile Exchange, gold for April delivery traded in a broad range between $1,212.10 and $1,240.90 an ounce before settling at $1,220.20, down 18.60 or 1.51% on the session. Despite the considerable losses, the precious metal has still soared by more than 14% since the start of 2016 and is on pace for one of its strongest opening quarters in nearly 30 years.

Gold likely gained support at $1,063.20, the low from January 4 and was met with resistance at $1,260.80, the high from Feb. 11.

On Friday morning, the U.S. Department of Commerce in a monthly report said that personal income and consumer spending surged by 0.5% in January, both eclipsing consensus' estimates. Driven by sizeable increases in wages and salaries, personal income rose for the third time in four months, building on strong gains from December. Consumer spending, meanwhile, moved steadily higher paced by a 1.2% spike in durable goods purchases.

More tellingly, the Personal Consumption Expenditure (PCE) Index jumped by 1.3% in January from its level 12 month earlier, an improvement of 0.7 from December's level. The Core PCE Index, which strips out volatile food and energy prices, rose by 0.3% from the previous month, extending monthly gains from December. On a yearly basis, Core PCE surged by 1.7% from its level in January, 2015, also 0.3% higher from December's reading.

While Core PCE inflation has remained under the Fed's targeted objective for every month over the last three years, January's reading hit the high end of the central bank's central tendency estimate for 2016. Fed chair Janet Yellen has continually reiterated that long-term inflation will continue to move toward the Fed's targeted goal of 2%, as temporary factors from a stronger dollar and record-low energy prices recede. At the Federal Open Market Committee's (FOMC) December meeting, the committee projected in its median forecasts that inflation will not reach 2% until 2018.

When the FOMC meets again next month, the committee will release its quarterly long-term economic projections, also known as its "dot-plot." The assessment includes long range projections for changes in Real GDP, unemployment, inflation and the Fed's benchmark interest rate. Since the FOMC ended a seven-year zero interest rate policy in December, threats of a global economic slowdown and extreme volatility in financial markets worldwide have prompted the U.S. central bank to reconsider its pace of tightening. The FOMC followed by holding the target range of the Federal Funds Rate at a level between 0.25% and 0.50% at a subsequent meeting in late-January.

But with the labor market nearing full employment, the strong inflation figures could compel the Fed to reconsider the timing of its next interest rate hike. In its January statement, the FOMC emphasized that it will continue to employ a data-driven approach when deciding whether it is appropriate to lift interest rates.

"A data-driven Committee, making decisions meeting by meeting, is likely to surprise markets from time to time," Fed governor Jerome Powell said at a speech before the U.S. Monetary Policy Forum on Friday morning.

Following the release of the monthly inflation data, the CME Group's (O:CME) FedWatch tool increased the probability of a June rate hike to 30.3%, up from 19.7% a day earlier. There is also a 49.3% chance that rates will remain unchanged for the rest of the year, according to the tool, down from 78.6% on Thursday.

Any rate hikes this year are viewed as bearish for gold, which struggles to compete with high-yield bearing assets in rising rate environments.

Separately, the Commerce Department upwardly revised Real GDP growth in the fourth quarter to 1.0%, up from initial estimates of 0.7%.

The U.S. Dollar Index, which measures the strength of the greenback versus a basket of six other major currencies, surged more than 0.80% to an intraday high of 98.29. The index reached its highest level in nearly three weeks.

Dollar-denominated commodities such as gold become more expensive for foreign purchasers when the dollar appreciates.

Silver for March delivery plummeted 0.425 or 2.80% to 14.745 an ounce.

Copper for March delivery surged 0.050 or 2.44% to 2.117 a pound.

Gold plunges, as strong inflation boosts hawkish case for 2016 rate hike

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