Gold investors can stop worrying. Despite recent chatter, interest rate tinkering at the Federal Reserve is not driving the price of gold.
That said, it’s easy to understand the confusion…
The price of gold dropped to a three-week low after the Fed released the minutes of its April meeting on May 18, suggesting it may lift interest rates in June. If U.S. employment figures are strong and inflation moves closer to the Fed’s 2 percent target, the U.S. central bank may raise the federal funds rate (the rate it charges to lend money to other U.S. banks). As you likely know, the Fed raised its benchmark rate last December for the first time since 2006.
On Friday, Federal Reserve Chairwoman Janet Yellen hinted again at higher rates, saying a rate hike would likely be appropriate “in the coming months.” If it is a similar hike to December’s, that means it will rise another quarter of a percentage point leaving the rate in a range of 0.5 – 0.75 percent – still very low.
Gold is now down 6.3 percent from the 2016 high it hit on May 2. Even the so-called “smart money” is pulling back a bit from gold in anticipation of higher interest rates. Earlier this week, Bloomberg reported that hedge funds have cut their gold holdings since January.
However, the truth is, a possible June rate hike is not the real reason gold prices have dropped. Gold dropped because higher rates would strengthen the U.S. dollar.
You see, when the Fed lifts interest rates, investors buy more U.S. dollars – because those dollars (after an interest rate hike) pay more interest. Gold, on the other hand, does not pay any interest. So, when investors can earn more holding other low-risk assets like the U.S. dollar, gold prices suffer. But that’s about the only way the Federal Reserve can influence gold prices
