21 February 2023

What Effect Do Fed Interest Rate Hikes Have on Gold Prices?


Have you ever wondered why the Fed raising interest rates in the USA is such a big deal? You’re not alone. Many new traders are mystified by the impact of certain news on global financial markets. 

Moreover, if you’re not in the US, why should you even be concerned? That’s a very valid question to have. And even if interest rates have increased, why is the gold market getting affected by it? 

We’ll be answering these burning questions, and debunking the link between fed interest rate hikes and gold price performance.

So without further ado, let’s dive straight in. But first..

What exactly is the federal interest rate?

The federal interest rate (aka: the federal funds rate) is the interest rate banks charge each other for overnight loans of their reserve balances at the Federal Reserve. 

Sounds complex? Let me give you an example. Let’s say the Federal Reserve sets the federal interest rate at 2%. 

This means that banks can lend their excess reserve balances to one another at 2% interest. Banks that need to borrow money overnight will pay this rate to other banks to acquire these funds. 

In turn, the banks use the federal interest rate to set their own lending rates for consumers and businesses. For example, a bank might set its prime interest rate at 5%, which is typically about three percentage points higher than the federal funds rate. 

This means that customers with good credit scores can borrow money from the bank at 5% interest, while those with less favorable credit may have to pay a higher rate.

Why does the Fed frequently tweak the Interest Rate?

The Federal Reserve tweaks the interest rate frequently to manage the country’s economy. Its primary objective is to promote maximum employment, stable prices for consumer goods, and moderate long-term interest rates.

To achieve these goals, the Fed uses monetary policy tools such as setting the interest rate to influence the amount of money in circulation within the economy. 

When the Fed lowers the interest rate, it becomes cheaper for banks to borrow money from one another – enabling them to lend more to businesses and consumers. 

This increased lending in turn leads to more spending and investment, which ultimately can end up stimulating economic growth and job creation.

On the other hand, when the Federal Reserve raises the interest rate, it becomes more expensive for banks to borrow money. This can slow down lending and spending in the economy. 

This can help to prevent inflation, which is a general increase in the prices of goods and services over time.

What effect do interest rate hikes have on Gold prices?

There’s a general view that federal interest rate increases are the “natural enemy” of the gold price.

According to this line of argument, higher interest rates are supposed to diminish the incentive for investors to buy gold as it “pays no interest”, which then in turn should lead to a lower gold price.

This point of view, however, is often criticized by some economists as too simplistic and inconsistent with gold’s historical performance. They argue that gold has had a special historic relationship with interest rates during past rate hikes.

Gold Price Behavior to Interest Rate Hikes in the Past

If we look at specific examples from the past, there have been recorded instances where gold prices have risen during periods of interest rate hikes. 

For example, in the late 1970s and early 1980s, gold prices soared in response to high inflation and a hawkish monetary policy by the US Federal Reserve.

More recently, during the period of interest rate hikes between 2015 and 2018, gold prices initially declined but then rebounded, as a combination of rising geopolitical tensions and fears of a global economic slowdown drove investors towards safe-haven assets like gold.

Overall, while there is no clear and consistent relationship between gold prices and interest rate hikes, a range of factors, including market sentiment and economic conditions, can influence gold’s price behavior.

What can you expect from a future fed interest rate hike?

Gold prices did see a recovery in 2023, reaching as high as $1,900 per ounce in mid-January as expectations for a slowdown in Fed rate hikes increased. 

Bankrate suggests that the Fed’s attempts to get inflation under control, which hit 6.5% in December 2022 compared to a year earlier, make it likely that the Fed will raise rates at its March 2023 meeting, which could impact gold prices. 

However, the full impact of a future Fed interest rate hike on the prices of gold is uncertain and may depend on various factors such as economic conditions, inflation rates, and global geopolitical tensions.

Key Takeaway

By now it should be evident to you what the federal interest rate is and why it’s frequently tweaked by the Federal Reserve. We’ve also established historical price reactions of gold to changes in the interest rate. 

Overall, Gold prices have been known to swing both ways in periods of interest rate hikes. In most historical cases, Gold prices have held strong and somewhat shown a bullish nature to interest rate changes as evidenced above. 

Keeping all these factors in mind, the next Fed meeting is scheduled to be held on 21-22 March, 2023. The rumor is they are going to go for a 50 basis point hike. 

So what will your move be? 

It can be a good opportunity to invest in gold trading as the yellow metal has a high chance of being bullish. 

Regardless of what your approach is, you can start gold trading online in 4 easy steps here and start locking in Gold profits from anywhere in the world with ISA Bullion. 

So why miss out on any future opportunities? Sign up and start trading instantly today. 

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