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  • XAU/USD bounced at the $1700 level on Wednesday but continues to trend to the downside.
  • Gold was unfazed by soft US data but will pay attention to Fed’s Powell on Thursday and NFP on Friday.

The gold bears are back in control on Wednesday, with spot prices (XAU/USD) resuming their steady decline and posting fresh seven-month lows for the second time this week of just above the $1700 level. The psychological level has proven a strong area of resistance, however, with XAU/USD bouncing back to trade closer to the $1720 mark. Still, on the day spot gold trades with losses of around 1.2% or over $20.

Downbeat US data did little to help the precious metal, implying that risks may be tilted to the downside heading into Friday’s official labour market report. A strong number could see gold drop below the big figure and open the door to an extension of downside towards resistance in the $1660-70 region.

Driving the day

Precious metal markets are taking a knock amid renewed upwards pressure on US government bond yields; 10-year yields are currently over 6bps higher on the day at just under 1.48% and nearly eclipsed 1.50% at one point earlier on in the session. 10-year TIPS yields (the 10-year yield adjusted for inflation expectations) is also up about 5bps on the session to -0.75%, though this is roughly where it started the week.

Higher bond yields tend to reduce the relative attractiveness of allocating capital to precious metals, hence weakness in gold. The fact that inflation expectations have risen back towards cycle highs, with 10-year break-evens back above the 2.20% mark for the first time since mid-February, has not come to gold rescue; markets remain confident that the Fed has inflation under control. Any sense that they are losing control over inflation would of course be very bullish for gold (the ultimate inflation hedge), but remains a long way off.

How high will the Fed allow bond yields to rise?

This is a hotly debated topic on Wall Street right now, with most desks agreeing that the Fed would be likely to act if 10-year yields rose towards the 2.0% level. In terms of how they might act, Fed officials have signaled that their first option would likely be to extend the weighted average maturity of their bond purchases, i.e. to buy more longer-maturity debt rather than short-term debt, given that the latter is seen as “well-anchored” amid expectations for low-interest rates for at least the next three years. Note that this is often referred to as a “twist” operation.

If the above failed to keep bond markets in check, the Fed could resort to either increasing the pace of monthly treasury purchases or by implementing a yield curve control policy ala the RBA or BoJ. This would not be the Fed’s preferred option, however, as going down either of these routes will make it harder to ease markets off of stimulus without triggering an adverse reaction when the time comes to start tightening policy down the road.

Fed Chair Jerome Powell will be speaking to the WSJ on Thursday, with his remarks scheduled for release at 17:05GMT and traders will be on the lookout for more information regarding all of the topics discussed above. In terms of what all of this means for gold; the more inclined the Fed is to intervene in bond markets and keep yields low the better. However, risks appear tilted to the downside in the short-term for gold given that, in order for the Fed to act with tweaked/more QE, yields are likely going to have to rise a lot more, which is itself a big negative for gold.