The gold market, historically a place of refuge for risk-averse investors, has always shown an intricate relationship with economic indicators and fiscal policies. This relationship is often amplified when major economies face adverse fiscal challenges. A recent case in point was the adjustment of the US sovereign debt credit rating by Fitch on August 1, 2023.
In a major move on Tuesday, Fitch, a leading credit rating agency, downgraded the United States' sovereign debt credit rating from AAA to AA+. This decision came on the back of projections for fiscal decline in the upcoming three years, increasing general government debt, and perceived governance erosion compared to AA and AAA-rated peers in the past two decades.
Despite the downgrade, US Treasuries rallied in price while yields dipped, suggesting that risk aversion trumped the implications for the US Government's borrowing costs. However, yields increased significantly in the US trading session on Tuesday, with the benchmark 10-year note trading around 4.06% before falling below 4% subsequently.
This news arrived after the Wall Street cash session had closed, leading to a dip in futures. Similar softness was seen in Asia-Pacific (APAC) equities. This development may lead to an increase in gold price volatility, especially if the theme of risk aversion persists.
Gold prices seemed to be in a state of flux following the downgrade. Despite movements in other markets, gold appeared directionless, which might be due to the imminent pressure on risk assets and the potential for increased volatility in the wake of Fitch's announcement.
The gold price has been oscillating with higher volatility ratios for nearly five months around the same general pivot points, reflecting the lack of a clear directional bias in the gold market. However, this range-bound movement could face notable support at the lower end, around the 1885 – 1895 area, characterized by several previous lows, a breakpoint, the 200-day SMA, and the 38.2% Fibonacci retracement level of the move from 1614 up to 2062. Alternatively, if the prices rally, resistance might be encountered near the recent peak of 1897 or the breakpoint close to 2000.
The gold market, while maintaining critical support above $1,980 an ounce, hasn't seen a major bullish momentum following the news of the downgrade. Despite a stable outlook assigned by Fitch and the Country Ceiling still being affirmed by the ratings agency at AAA, there was no significant positive drive in gold prices.
The reasoning behind the downgrade points towards fiscal challenges and governance issues. Fitch noted the political standoffs related to the debt limit and delayed resolutions, coupled with an absence of a medium-term fiscal framework, unlike most peers. This, along with a series of economic shocks, tax cuts, and new spending initiatives, resulted in consistent debt increases over the last decade.
Fitch projects the US general government deficit to rise to 6.3% of GDP in 2023, up from 3.7% in 2022, and to further grow by 6.6% and 6.9% of GDP in 2024 and 2025, respectively.
The history of US credit rating downgrades offers some interesting insights. When the US credit rating was last downgraded, it sparked a rally that led to then all-time highs above $1,900 an ounce, according to Adam Button, chief currency strategist at Forexlive.com.
John LaForge, head of real asset strategy for Wells Fargo Investment Institute, stated that the growing US debt could be a significant bullish factor for gold, potentially supporting higher prices for at least the next three years.
Still, the immediate market impact of Fitch's downgrade might be limited, given the relative resilience of the US economy with respect to slowing and shrinking inflation in many areas and a strong labour market. Economists at Capital Economics note that downgrading the US during a period of promising economic performance might seem odd.
The future trajectory of the US economy and hence the gold prices depends significantly on inflation and interest rates. If inflation continues to ease, the Federal Reserve could reduce rates again by next year, thereby reducing the Federal government's borrowing costs. On the other hand, if the nominal interest rate remains above the rate of nominal GDP growth for an extended period, the debt dynamics could quickly become unsustainable, which could be a critical determinant of gold prices.
The downgrade of the US credit rating by Fitch sets the stage for an interesting dynamic in the gold market. The immediate impact on gold prices has been somewhat muted, but the longer-term implications, given the historical view, could be significant.
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