Fed "Holds Steady" Amid Middle East Conflict? What's Next for Gold?

The two-day U.S. Federal Open Market Committee (FOMC) meeting is currently underway.

The Middle East situation has triggered a surge in oil prices, coupled with a softening U.S. labor market. The market is already pricing in a “wait-and-see” approach from the Federal Reserve for this meeting, with the latest federal funds rate futures also indicating that expectations for rate cuts this year have been reduced to one.

However, while markets anticipate the Fed will keep the benchmark overnight rate in the 3.50%–3.75% range, all eyes are on the signals the FOMC may send regarding future rate directions.

Stephen Stanley, Chief U.S. Economist at Santander Bank, said that after the last meeting, the Fed had already ruled out the possibility of a rate cut in March. The Middle East conflict has further caused the Fed to adopt a wait-and-see stance.

Li Huiqi, Macro Strategist at UBS Wealth Management Investment Office, told First Financial that although the Fed usually tends to filter out short-term energy price fluctuations, if high inflation persists for too long, markets will worry about a repeat of the inflation runaway risk following the Russia-Ukraine conflict in 2022. Once consumer inflation expectations rise across the board, markets will have to reprice the rate cut path, or even start to expect rate hikes.

Middle East Conflict Reshapes Inflation Expectations

Currently, market expectations for rate cuts within 2026 have been pushed back from mid-year to the end of the third quarter or even the fourth quarter. The January FOMC minutes show significant opposition within the Fed to further rate cuts. Boston Fed President Collins, Cleveland Fed President Harker, and others believe that weak employment data have not changed their view that interest rates may remain unchanged for a considerable period.

The subsequent surge in oil prices caused by the Middle East conflict is literally “adding fuel to the fire.”

On the 12th, Brent May crude futures rose 9.2%, closing at $100.46 per barrel, the first time since August 2022 to close above the psychological level of $100. On the 18th, as of First Financial’s press time, WTI crude was at $95.97 per barrel, and Brent was at $100.63 per barrel.

The transmission chain of rising oil prices generally follows a highly consistent pattern: extending from upstream energy to midstream chemicals, then entering the real economy and amplifying through financial channels, ultimately potentially affecting downstream agricultural products.

For example, on March 16, local time, as conflicts in the Middle East disrupted global energy supply, the retail price of U.S. diesel exceeded $5 per gallon for the second time in history.

Li Huiqi noted that this impact has now significantly spilled over from the single crude oil market to the entire industry chain. Take natural gas as an example: Qatar’s suspension of LNG production has caused nearly 20% of global supply to be interrupted. This is a heavy blow to Europe, which currently has natural gas inventories at only about 30% of recent lows—at a critical replenishment window—driving European natural gas futures prices higher.

“Additionally, Iran, as a major global natural gas exporter and the second-largest urea exporter, has seen its fertilizer exports disrupted due to sanctions and shipping risks,” she explained. The challenges are also severe in agriculture and food sectors. The Gulf countries rely heavily on food imports, with about 80%–90% of supplies needing external input. Shipping disruptions threaten regional food logistics security, pushing up food prices.

She emphasized to reporters: “The macro impact on the real economy will be a key observation over the next month. Our estimates suggest that if oil prices stay above $90 for more than six months, U.S. annual inflation could rise by about 60 basis points; if prices climb above $120 and remain there for over six months, inflation could increase by as much as 150 basis points.”

Cameron Systermans, Head of Multi-Asset at Mercer Asia-Pacific, told First Financial that unless the shock is large enough and lasts long enough to trigger a secondary inflation effect, the rise in energy and transportation costs alone is unlikely to substantially alter the current rate-cutting pace of the Fed and ECB. “Our baseline forecast remains that the Fed will continue to cut rates this year, and we believe the ECB has completed its easing cycle,” he said.

He cited a Fed study indicating that if the shock is large and persistent, overall inflation could rise: “A $10 increase in oil prices could add about 40 basis points to U.S. inflation over several quarters, with core inflation contributing about 15 basis points at its peak.” Additionally, insurance rates for ships passing through the Persian Gulf could surge by up to 50%, which is also a key risk in supply chain costs.

However, Systermans currently considers these risks as short-term or conditional volatility. He believes that as long as shipping through the Strait of Hormuz quickly recovers and there is no major infrastructure damage, oil prices are expected to fall back.

Hu Jie, a former senior economist at the Federal Reserve and professor at Shanghai Jiao Tong University’s Shanghai Advanced Institute of Finance, recently told reporters that the Fed is always focused on assessing whether overall inflation levels meet policy targets. Official statements often mention key indicators like the core Consumer Price Index (CPI), Producer Price Index (PPI), and core Personal Consumption Expenditures (PCE), but internally, the Fed considers dozens of more detailed sub-indicators.

He said that if energy prices continue to soar, it will have an extremely adverse impact on inflation management. As a fundamental input to modern economic activity, rising energy prices are highly permeable and tend to transmit to all goods and services. “Therefore, from the Fed’s perspective, this event warrants close attention.”

Gold Market Outlook

Since the Middle East conflict, gold’s performance has differed from the previous Russia-Ukraine conflict, where its safe-haven attributes were more prominent.

After an initial rally, gold has mostly traded within a $5,000 per ounce range, lacking a clear upward breakout path, and market direction is awaiting the FOMC’s outcome.

Li Huiqi told reporters that gold and the dollar are highly correlated. In the short term, geopolitical tensions have led markets to seek safe assets again, strengthening the dollar and Swiss franc, with the dollar index rising above 100, which to some extent puts downward pressure on gold prices.

“Additionally, gold has already seen significant gains since the start of the year and is at a relatively high level. In the early stages of geopolitical conflicts, markets tend to sell off profitable, liquid assets first to raise cash for margin calls or future investments. This liquidity demand initially suppresses gold prices,” she explained. However, historically, gold tends to be more resilient than risk assets during major geopolitical events. Although prices had already factored in a considerable rally before this conflict, in the medium to long term, gold supply remains relatively stable.

Li Huiqi believes that, from a macro perspective, as the conflict evolves, the Fed will eventually revert to fundamental logic, leaving room for rate cuts. Meanwhile, global central banks continue to increase gold holdings for reserve diversification, providing solid support for gold prices. Therefore, she sees gold as having stable upside potential.

“We expect gold prices to reach around $6,000 per ounce by mid-year. Although fluctuations may occur due to market positioning or valuation adjustments, increasing gold exposure is important for hedging portfolio risks and reducing overall volatility,” she added. “After reaching a high mid-year, prices may retreat by year-end. Typically, after U.S. elections or mid-term elections, market expectations for political risks are re-priced. Therefore, our target price for the end of the year is around $5,900, slightly below the June forecast.”