Gold declines because dollar funding demand is surging?

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Gold encountered historic selling this week, and market indicators suggest that this may be driven by a sharp rise in global dollar financing demand.

This week, spot gold fell about 8.5%, marking its worst weekly performance since March 2020. At one point during trading, gold prices dropped as much as 10%; if calculated this way, this would be the largest weekly decline since 1983.

It is worth noting that the sharp decline in gold mainly occurred during the Asian and European trading sessions. This phenomenon has triggered market speculation: Is the plunge in gold a “canary in the coal mine” for an emerging dollar financing crisis?

Initial Signs of Rising Dollar Demand

The underlying liquidity of the global financial system appears to be coming under pressure. According to observations from UBS traders, considerable volatility has appeared in the currency basis for JPY/USD and CHF/USD.

The cross-currency basis is an important indicator measuring the cost for non-U.S. institutions to obtain dollars. A wider basis typically means the cost of obtaining dollars in offshore markets is rising, indicating increasing global demand for dollars.

When facing dollar shortage pressure, investors often prioritize selling highly liquid assets like gold to obtain urgently needed dollar cash. Suki Cooper, Global Head of Commodity Research at Standard Chartered Bank, said: Liquidity demand in other areas (such as dollars) continues to suppress gold’s geopolitical risk premium.

Signals of Pressure in Financing Channels

Apart from the cross-currency basis, other indicators that measure potential pressure in market financing channels are also sending signals. Swap spreads are widening significantly.

An increase in swap spreads usually reflects tightness in bank balance sheet space or growing concerns about counterparty risk in the market. These phenomena and logic point to one possibility: the global market may be experiencing some degree of dollar liquidity tightening.

Market Repricing of Federal Reserve Policy

If dollar financing pressure continues to rise, it could affect the Fed’s monetary policy. Currently, market pricing shows investors expect the Fed will not cut rates this year.

However, according to Bloomberg, in recent trades, the SOFR (Secured Overnight Financing Rate) options market saw several sizable bullish flows. These trades appear to be hedging tail risks—betting that the Fed may cut rates as many as twice by 25 basis points each in the coming weeks.

Such hedging behavior indicates some market participants are guarding against the risk that a sudden liquidity event could force the Fed to take emergency action. Although for now, liquidity tools such as the Fed’s discount window have not shown signs of large-scale use, underlying market logic is subtly changing.

Signals of global central banks turning hawkish are also pressuring gold. WallstreetCN analysis shows that the core driver of this round of gold decline lies in the reversal of interest rate expectations, as central banks in the U.S. and Europe have successively sent hawkish signals. The Middle East conflict triggered sharp rises in oil, natural gas, and fuel prices, raising market concerns over global inflation. Since gold does not generate interest income, contraction in rate cut expectations directly weakens its relative appeal.

Meanwhile, retail investors are continuously net-selling gold ETFs, CTA hedge funds are actively cutting long positions, and liquidity pressures are exacerbating the sell-off.

Risk Warning and DisclaimerThe market involves risks, and investment needs to be cautious. This article does not constitute personal investment advice, nor does it consider the special investment objectives, financial situation, or needs of individual users. Users should consider whether any views, opinions, or conclusions in this article are suitable for their particular situation. Investment based on this article is at your own risk. ```