(Kitco News) - The Federal Reserve’s new tightening bias has created significant hurdles for the gold market, forcing one bank to curb its bullish enthusiasm for the time being.
When gold started its unprecedented rally last year, Bank of America was one of the most bullish voices in the market. In January, the bank said it expected gold prices to hit $6,000 an ounce by the spring. However, the significant correction over the last few months has prompted the bank’s metals research team, led by Michael Widmer, to revise its short-term outlook.
“Hitting our $6,000/oz target looks unlikely for now. But the ongoing U.S. macro combination of high deficits, lack of fiscal consolidation and resulting funding needs — the premise behind our original bullish gold call — suggests there is still fuel in the tank for gold to rally again over the longer term,” the bank said in its latest precious metals report.
Widmer explained that shifting expectations around U.S. monetary policy remain the biggest obstacle for gold in the near term. At the start of the year, markets were expecting the U.S. central bank to cut rates this year; however, the war in Iran, which has created a global energy crisis, has led to a dramatic increase in inflation pressures. As a result, markets have started to aggressively price in rate hikes before the end of the year.
According to the CME FedWatch Tool, markets see a more than 70% chance of a rate hike by September.
“The increased probability of rate hikes into December 2026 has been closely correlated with a decline in gold prices. Or, put a different way, the shift from "inflationary cuts" to tighter monetary policy reduces gold upside by around 50%, all else being equal,” Widmer said.
BofA also noted that even if a lasting peace deal is negotiated, inflation pressures are unlikely to ease.
“In a world of greater geopolitical fragmentation, this is unlikely to subside anytime soon. Amid higher global supply chain pressures and rising producer prices, the outlook for inflation is not particularly encouraging. In addition, services inflation was persistently above target in the past, but negative goods inflation helped achieve the Fed's price stability target. However, core goods inflation spiked after Covid, and after coming down, Trump tariffs delivered another blow. Meanwhile, housing disinflation helped keep a lid on core inflation, but that support is likely to fade following its reversal,” the analysts said.
However, while elevated inflation will force the Federal Reserve to maintain a hawkish monetary policy stance, BofA said it sees other structural issues supporting higher gold prices.
“U.S. economic policy remains unorthodox. Indeed, the fiscal deficit continues to run at around 6% of GDP, while foreign holdings of U.S. Treasuries have declined. According to the latest central bank gold survey, the majority of respondents (74%) expect moderate or significantly lower U.S. dollar holdings within global reserves over the next five years,” the analysts said. “Until that backdrop changes, we believe there is still some fuel left in the tank to push gold higher again, despite the near-term headwinds.”
Widmer’s team also sees further potential demand from retail investors. The bank acknowledged that gold needs the market to price out rate hikes again, and if that happens, investment demand could drive further upside. The analysts noted that physical and paper gold investments now account for around 5.5% of total equity and fixed-income markets.
“Hence, there is still room for investors in the shift from a 60:40 to a 60:20:20 portfolio,” the analysts said.
