How Will Gold Prices Be Affected by Interest Rate Increases?

several bars of gold

In 2021, gold has experienced a lot of volatility, suffering the worst crash it has had in six years. It occurred despite an increase in inflation, which ideally should have increased the attractiveness of gold for investors as a traditional hedge against inflation. However, other than a few increases, gold underperformed expectations.

The U.S. Federal Reserve recently indicated in its December meeting minutes that it will likely increase interest rates soon to help to curb rising inflation. In the Eurozone and the US, inflation reached multi-year highs, after many stimulus measures were implemented due to the pandemic.

It has made it necessary for the central banks to make a decisive move. The first financial institution that tightened monetary policy was the Bank of England, followed quickly by the US Federal Reserve, as recently inflation in the US reached its three-decade high. There is speculation that the US Fed will implement three rate hikes at least if not four, this year.

Rate Hikes are Imminent

Interest rate increases are expected soon, and investors have speculated about how they will impact this year’s gold prices, considering the recent performance of gold. In August 2020, gold hit its record high at $2,000 per ounce. However, ever since it has not been able to recover, despite the steady rise of inflation.

Historically, when there has been an increase in interest rates, the prices of gold have gone down, as investors are looking at other asset classes like equities or bonds that are offering higher returns. It is not clear whether this will continue to be true this year for gold, as the exact timeline of the interest rate hikes by the Fed is still unknown.

However, at least for the moment, the sentiment is very positive for gold, as prices keep increasing, including recently reaching a one-week high.

What are Interest Rates?

The Federal Reserve has a target federal fund rate, which is often referred to more broadly by the media as “interest rates,” It is the estimated overnight lending rate set by the Federal Reserve for credit unions and banks.

A certain cash reserve amount must be held by credit unions and banks at the end of every day. Therefore, they tend to borrow and lend from one another overnight to make sure they meet their reserve requirements (or lend excess cash to receive some extra income).

With the targeted federal funds rate, a range of 0.25% is given on the interest rate that credit unions and banks must be within when the interest rates for the overnight loans are determined.

Whenever the Federal Reserve is looking to curb inflation and excess spending, it introduces tighter monetary policy and increases interest rates, which marks the start of a tightening cycle. It then has knock-on effects on almost every public-facing or business interest rate and then almost every asset in turn.

Resilience showed by Gold

Higher interest rates will usually place pressure that leads to reduced gold prices. This makes recent activity with gold much more interesting. Despite tightening, gold is seeing strong support not only with prices but at rates that haven’t been seen since before the financial crisis. Although many people still think that the fundamentals will end up being too large of a barrier this year for gold and that prices will go down, current price action is impossible to ignore and could continue showing strong resilience for quite some time.

The mid-to-long-term sentiment appears to be mainly bearish, as seen by the comment above, the short-term outlook appears o be positive for the most part, with investors still hoping that gold might recover part of the ground that it lost over the past year.

Many analysts believe gold is pushing back to a resistance ranging from $1,730/ounce to $1736/ounce. Although gold has experienced significant resistance over the past year in this range, investors are still hopeful that this year it will finally be able to break through the traditional barrier.

If that happens, most likely gold will reach the high from last September of $1,7990/ounce, which could pave the way for additional gains in the future, or at least until the interest rates have been tightened even more.

Because of the price action in gold, the weakness in the dollar, unstoppable inflation, and rampant government spending, more and more people are trying to protect their wealth with physical precious metals.  To learn more, you may want to read this Goldco Precious Metals IRA review.

Weakness in the U.S. dollar

Gold has benefitted from the weakness of the US dollar, with traders unwinding their aggressive bets on this currency. The pound sterling has steadily gained against the US dollar over the last couple of days, and this trend might also continue over the near future.

Other analysts think that despite the expectations of the markets, there will be significant increases in interest rates over the next couple of months, with investors very interested in gold.

It is also believed by some that if gold can cross a resistance range of around $1,730/ounce to $1,736/ounce, this year might experience more recoveries, while a reduction to around $1,790/ounce could be a sign of further distress.

By contrast, the rise of Bitcoin as well as NFTs and other digital assets might join with interest rate forces to contribute to lower gold prices this year, with more investors turning to these as inflation hedges. It is a trend that most likely will continue to grow this year with more cryptocurrency-linked ETFs making their way to the market, while investors have more choices when it comes to what form and how they want to invest.

There are other dynamics at work as well that must be considered as well such as the pandemic continuing to progress, and demand, and supply chain factors when factoring in increased interest rates on this year’s gold prices.

Gold vs. Trust in Central Banks

However, gold prices are impacted by trust in central banks. When inflation in the US reached a 14.8% high in 1980, in 1981 the Fed responded by increasing rates to 20%. After that gold prices dropped significantly. However, this had very little to do with the actual rates. Instead, rate increases restored the public’s belief in the central banks. In turn, this made it possible for people to think that the Fed had good control over the economy.

In 2012, the ECB’s Mario Draghi said he was willing to do whatever it took for the ration ratio to be preserved. In reality, not much was done by the ECB. However, the words of Draghi were sufficient for restoring trust in the central bank, and in turn, this affected gold as well.

Writen by cwclark