Gold fell as optimism that the Federal Reserve will cut interest rates next month was shaken by continued uncertainty over economic data, following the longest government shutdown in U.S. history.

Expectations for a Fed rate cut declined as the week progressed, with Fed officials showing little confidence in reducing borrowing costs. Higher interest rates typically make non-yielding bullion relatively less attractive to investors.

Traders are now divided on the likelihood of a December rate cut, having previously expected a quarter-point cut less than a month ago. Attention now turns to comments from three Fed officials due to speak on Friday, including voting member Jeffrey Schmid.

Several Fed officials "have signaled that they would be uncomfortable with further rate cuts without reliable data on the labor market and inflation," wrote Thu Lan Nguyen, head of currency and commodity research at Commerzbank AG, in a note on Friday. "Therefore, there is a risk that the majority will decide against raising interest rates in December for the time being, until the picture becomes clearer."

Gold's recent high correlation to riskier assets suggests that the unwinding of the currency depreciation trade is starting to take place later in the year, according to TD Securities. "Government bonds outperform gold as a safe-haven asset during this period of risk aversion," said Dan Ghali, senior commodity strategist, in a note.

The precious metal experienced increased volatility this week, which may have been exacerbated by a so-called "gamma squeeze," a technical pattern in which traders selling low-priced options are forced to buy gold futures as a hedge. In a thin market, a sudden price increase can increase the urgency to buy and escalate into a surge even without new demand from physical buyers.

Ghali said this week's gold rebound aligns with this dynamic. He noted that the recent decline in over-the-counter trading volumes has made the market more susceptible to influence. "This liquidity vacuum may actually be the key to creating a gamma squeeze, which resulted in a second, higher shock wave this week," he said.

Gold bullion is still up about 55% this year and remains on target for its best annual performance since 1979. Central banks have stepped up purchases, seeking a store of value and asset diversification, while investors have piled into the metal as a hedge against growing fiscal unease in some of the world's largest economies.

Gold fell 2.2% to $4,078.14 an ounce as of 10:34 a.m. in New York. The Bloomberg Dollar Spot Index was little changed. Silver fell 2.4% to $51.06 an ounce, while platinum and palladium also fell. (alg)

Source: Bloomberg