The consequences of the Feds rate hike..

April 17, 2015 10:51 AM

As we have pointed out in an earlier edition of the Market Overview, the Fed’s hike alone would not negatively affect gold prices.

The real interest rates or U.S. dollar index are much more important for the gold market than single changes in the federal funds rate. According to Barclays analysts, apart from the “hiking cycle of 2004-06, gold prices tend to fall 2 percent in the three months leading up to the rate hike,” but everything depends on the economic context.

After the surprising announcement of the interest rates hike in 1994 the gold prices fell from $388 to $380 (see the chart below), however during the whole tightening cycle the yellow metal was traded sideways, because the U.S. dollar was falling during the whole of 1994.

The last tightening cycle from 2004 to 2006 did not disrupt the gold boom in 2000s. Again, it was a time of a falling U.S. dollar. For most of 1999 the gold price was falling only to rise from $270 to $323 in October 1999 following an agreement to limit gold sales by 15 European central banks. It shows that the gold prices depend on many factors and may rise on worries about the Eurozone economy, despite the Fed’s tightening.

Gold prices (London PM Fix, green line) and Federal Funds Rate (red line) from 1993 to 2006.

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Indeed, with ultra-low yields on European and Japanese bonds, investors should shift their capital to the U.S. bond market. A possible demand for U.S. Treasuries would keep long-term interest rates low, which would support the gold prices. In other words, if the Fed's tightening is gradual and correctly anticipated, and interest rates remain low by historical standards, the impact on gold should not be huge.

This is exactly what the economists are expecting right now. The first move will be rather small, probably a quarter of a point, and it will be carefully signaled to the market to prevent any surprise. However, the strong U.S. greenback seems to be a headwind for the yellow metal, at least in the coming months before the Fed’s hike.

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About the Author

Arkadiusz Sieroń is a certified Investment Adviser. He is a long-time precious metals market enthusiast, currently a Ph.D. candidate, dissertation on the redistributive effects of monetary inflation (Cantillon effects). Arkadiusz is a free market advocate who believes in the power of peaceful and voluntary cooperation of people. He is an economist and board member at the Polish Mises Institute think tank. He is also a Laureate of the 6th International Vernon Smith Prize.