Would A Rate Hike Have A Negative Effect On Gold

Monday, February 29, 2016

gold barFor more than a year, the United States Federal Reserve has been a primary topic of discussion in the finance realm, and for good reason. In late 2014, the Fed said that it would be increasing its historically low interest rate by the end of the year in 2015. While their attempts were delayed, in December, they finally made the decision to increase their rate by 0.25% to 0.50%. However, that's not the only thing the Fed did in December. They also announced that they would be raising their interest rate between 2 and 4 times by the end of 2016. So naturally, we're seeing a ton of discussion about whether or not the Fed will be raising its rate and how it will affect the financial market if this is done. One of the big questions on the minds of gold investors is, “Will a rate hike cause a reduction in the price of gold?” Today, we'll talk about the history of the correlation between interest rates and gold, whether or not a rate hike will cause a decline in the value of gold, and whether or not the Fed is likely to follow through with its plans in the first place.

How Rates Generally Affect Gold

In general, when the Federal Reserve increases its interest rate, it will cause a decline in the value of gold. There are two reasons for this movement...

  • Economic Insight – Gold tends to rise under negative economic conditions. However, when the Federal Reserve raises its interest rate, what it is saying is that it has faith in economic growth in the United States. Therefore, historically, when the interest rate is increased, we see reductions in the value of gold.
  • Currency Changes – Another big factor here is currency values. You see, when the Federal Reserve raises its interest rate, what it really is doing is increasing the value of the United States dollar. Because gold is priced using the USD, this can cause resistance as the precious metal becomes more expensive outside of the United States, leading to lackluster demand in other nations.

Would A Rate Hike Cause The Value Of Gold To Fall

In my opinion, we are in the midst of a very unique scenario. One in which a rate hike would likely fail to cause the value of gold to fall. There are a couple of reasons for my opinion on this...

  • Market Conditions – First and foremost, gold is a safe haven investment, which means it tends to climb in value when the market does poorly. Unfortunately, market conditions are far from positive. If the interest rate were to increase, it would only lead to further uncertainty in the market and further resistance. So, market values would likely decline further, sending safe haven investors toward the precious metal and leveling out demand.
  • Global Economic Conditions – Another thing worth keeping in mind here is that global economic conditions are far from positive, and a rate hike would only exacerbate issues around the world. Ultimately, this would lead to further demand increases in the precious metal and ultimately growth in value.

Is A Rate Hike Even Likely?

In my opinion, I don't believe that we're going to see more than one rate hike. However, I do think that a rate hike is coming down the line. The reality is that some US economic data is proving to be positive. So, I wouldn't put it past the Federal Reserve to make the mistake of increasing its rate. However, after the first rate hike of the year, we would likely see an overwhelmingly negative reaction in the economy and in the market. This would likely hinder the Fed's plans to increase its rate a second time in the year 2016. 

Joshua Rodriguez

Joshua Rodriguez is an avid financial professional. He is the owner and founder of CNA Finance, a partner at Modest Money, and a writer for US News & World Report, Investing.com, and more! Joshua takes a strong fundamental approach to market analysis and enjoys offering his take on what we can expect moving forward. You can reach Joshua at cnafinancehelp@gmail.com.