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(Kitco News) - The gold market continues to tread water at a critical long-term support level as investors wait to see how far the Federal Reserve will go to get inflation under control.

Markets expect the U.S. central bank to raise interest rates by 75 basis points; however, many economists will be paying attention to the Federal Reserve's updated economic projections, also known as the dot plots.

Persistently higher inflation in August has forced markets to adjust their expectations regarding how high Fed Funds rates will rise. According to the CME FedWatch Tool, markets see interest rates rising as high as 5% within the first half of 2023.

However, according to the latest report from Joe Foster, portfolio manager and strategist, and Imaru Casanova, deputy portfolio manager of the VanEck International Investors Gold Fund, the Federal Reserve could be closer to the end of it aggressive tightening cycle than markets currently expect.

"The Fed can try to control inflation on the demand side by increasing rates and quantitative tightening, which slows economic growth. However, based on the experience of the seventies, the current slow rate of Fed tightening may not be sufficient to return inflation to its two percent target. There might also be a limit to how high the Fed is willing to hike rates," the portfolio managers said in the report.

Not only do Foster and Casanova not expect the Fed to bring inflation back down to 2% anytime soon, but they said that the central bank could face growing political pressure to end its tightening cycle as rising interest rates will make servicing its debt more expensive.

The Federal Reserve's balance sheet, while falling, is valued at $8.8 trillion.

Quoting data from the Wall Street Journal, Foster and Casanova said that if the Fed raises interest rates to between 3.25% and 3.50%, it would cost the Treasury $195 billion annually to fund the U.S. central bank.

"As the targeted Fed Funds rate (currently 2.5%) rises above 3%, the interest it pays will exceed the revenue gained from its portfolio assets," the analysts said.

Looking at the broader economy, unprecedented government spending in the last two years due to the global pandemic has pushed the national debt to $30.9 trillion.

In a report in July, the Congressional Budget Office said that the government could end up paying $1.2 trillion in interest payments by 2032.

Foster and Casanova said that the federal government, despite its best efforts with the Inflation Reduction Act, will not do much to ease rising consumer prices.

"The Act's components have us wondering if it might actually stoke further inflation," the analysts said. "The bill has a number of green energy credits and perks. While this may benefit the environment, green energy costs more than fossil fuels and increases demand for metals, keeping upward pressure on prices. In addition, while the Administration claims that the Inflation Reduction Act's lowers deficits can decrease inflation, the last four bills passed by the Administration along with student debt relief will combine to substantially raise the budget deficit."

The analysts said that they expect it's only a matter of time before consumers see inflation as a threat again.

"We believe that at some point, the markets will lose patience with the Fed's talk and see that inflation is indeed out of control. Such an awakening would benefit gold," the analysts said.

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