One of the most important themes in financial markets at any given time is the policy trajectory of the US Federal Reserve.
Often referred to as the Federal Open Market Committee (FOMC), this is the group of decision-makers in the Federal Reserve System that help the US economy run as smoothly as possible.
As the scope and potential impact of the Financial Crisis was starting to materialize in 2007-2008, the FOMC dropped interest rates to help ease access to money in the United States. When interest rates are low, individuals and organizations theoretically have more incentive (or ability) to take out loans because the cost of servicing the loan (interest payment) is cheaper.
This activity helps counteract any deterioration in the economy that may be associated with banking issues, geopolitical events, or other.
When the stress on the economy dissipates, and the balance sheets of individuals and companies get healthier, easy access to credit can transform into a race for resources. At this point in the economic cycle, demand for goods picks up substantially. And because demand often outpaces supply during these periods, prices go up.
Rising prices are a symptom of an inflationary environment, which can ultimately result in an overheated economy that is susceptible to bubbles and ensuing crashes. The Federal Reserve monitors economic data constantly and will raise interest rates (making loans more expensive) in order to “cool-off” a strengthening economy.
Due to the severity of the 2008-2009 Financial Crisis, the Federal Reserve maintained extremely low interest rates for an extended period (nearly a decade) to insure that the economy could heal itself. However, having made three interest rate hikes in roughly 14 months, the FOMC now appears to be implementing policies that are intended to “normalize” interest rates, while also preventing excessive inflation.
A recent episode of Futures Measures covers the interest rate tool of the FOMC, known as the Federal Funds Rate (FFR). Additionally, the episode examines the relationship of the FFR and the price of gold over time.
As we know, gold tends to move in the opposite direction of the US Dollar. When economic conditions deteriorate, interest rates usually fall (along with the US Dollar), and the price of gold tends to get a boost. During the reverse periods, when interest rates are rising (along with the US Dollar), the price of gold can experience headwinds.
A 10-year gold chart shows clearly that the Great Recession pushed the price of gold up significantly. However, during recent years, the price of gold has dropped - especially as interest rates have increased.
One thing to remember is that gold prices can also fluctuate based on geopolitical events, or other developments that contribute to increased uncertainty in financial markets. The general uncertainty of the political climate in the United States under President Trump makes the current gold trade even more intriguing.
On this episode of Futures Measures, the team examines the performance of gold during other periods in history when interest rates were rising. If you want to learn more about the respective movement of interest rates and gold in history, we highly recommend taking the time to review the complete episode.
Two findings from this research are particularly interesting. Based on the data reviewed by tastytrade, gold looks particularly susceptible to a sell-off when it is closer to the peak of a bull run as interest rates reverse course (and start rising).
Secondly, the degree of impact on gold price movement also appears to be correlated with the speed of the rate increases. A more gradual increase in interest rates hasn't been as destructive to gold, as compared to more rapid interest rate increases.
The topics discussed on Futures Measures may help you formulate a market assumption that helps unlock additional value in your portfolio.
The next two FOMC meetings are scheduled for May 2-3 and June 13-14. Paying close attention to the expectations for further interest rate hikes may allow you to put your newly formulated market assumptions to work, assuming an opportunity presents itself.
In the meantime, if you have any questions about trading interest rates or gold, we hope you'll reach out at firstname.lastname@example.org.
Thanks for reading!
Sage Anderson has an extensive background trading equity derivatives and managing volatility-based portfolios. He has traded hundreds of thousands of contracts across the spectrum of industries in the single-stock universe.