Gold is a precious metal that has been used as a store of value and a hedge against inflation for centuries. Gold prices are influenced by many factors, such as supply and demand, geopolitical events, currency movements, and market sentiment. However, one of the most important factors that affect gold prices is the monetary policy of the U.S. Federal Reserve, especially the federal funds rate and the Federal Open Market Committee (FOMC) meetings.
## What is the federal funds rate?
The federal funds rate is the interest rate that banks charge each other for overnight loans of reserves held at the Federal Reserve. The Fed does not directly set this rate, but it influences it through its open market operations, which involve buying and selling Treasury securities and other assets. The Fed adjusts the federal funds rate to achieve its dual mandate of price stability and maximum employment.
The federal funds rate affects other interest rates in the economy, such as the prime rate, the mortgage rate, the Treasury yield, and the LIBOR rate. These interest rates affect the borrowing and lending activities of consumers, businesses, and governments, which in turn affect economic growth, inflation, and exchange rates.
## What is the FOMC?
The FOMC is the policy-making body of the Federal Reserve that consists of 12 members: seven members of the Board of Governors and five presidents of the regional Federal Reserve Banks. The FOMC meets eight times a year to review economic and financial conditions and decide on the appropriate stance of monetary policy.
The FOMC announces its monetary policy decisions in a statement that summarizes its assessment of the current and future economic outlook and its policy actions. The FOMC also publishes a summary of economic projections (SEP) that shows its forecasts for key economic variables such as GDP growth, unemployment rate, inflation rate, and interest rates. The FOMC also holds a press conference after four of its meetings to explain its policy decisions and answer questions from journalists.
## How do the federal funds rate and the FOMC affect gold prices?
The federal funds rate and the FOMC affect gold prices mainly through their impact on inflation expectations, opportunity cost, and market sentiment.
• Inflation expectations: Gold is often seen as a hedge against inflation because it tends to maintain its purchasing power over time. When inflation expectations rise, investors tend to buy gold to protect their wealth from eroding. Conversely, when inflation expectations fall, investors tend to sell gold to seek higher returns elsewhere. The federal funds rate and the FOMC affect inflation expectations by signaling their stance on inflation. When the Fed raises or signals to raise the federal funds rate, it indicates that it is concerned about rising inflation and wants to cool down the economy. This tends to lower inflation expectations and weigh on gold prices. When the Fed lowers or signals to lower the federal funds rate, it indicates that it is not worried about inflation and wants to stimulate the economy. This tends to raise inflation expectations and support gold prices.
• Opportunity cost: Gold is a non-yielding asset that does not pay any interest or dividends. Therefore, holding gold involves an opportunity cost of foregone income from other assets that do pay interest or dividends. The federal funds rate and the FOMC affect the opportunity cost of holding gold by influencing other interest rates in the economy. When the Fed raises or signals to raise the federal funds rate, it makes other assets more attractive relative to gold because they offer higher returns. This increases the opportunity cost of holding gold and puts downward pressure on gold prices. When the Fed lowers or signals to lower the federal funds rate, it makes other assets less attractive relative to gold because they offer lower returns. This decreases the opportunity cost of holding gold and puts upward pressure on gold prices.
• Market sentiment: Gold is also a safe-haven asset that investors flock to during times of uncertainty, risk aversion, or crisis. The federal funds rate and the FOMC affect market sentiment by influencing the outlook for economic growth, financial stability, and global trade. When the Fed raises or signals to raise the federal funds rate, it may dampen market sentiment by raising concerns about slowing growth, tighter financial conditions, or trade tensions. This may increase demand for gold as a safe-haven asset and boost gold prices. When the Fed lowers or signals to lower
the federal funds rate, it may improve market sentiment by easing worries about recession, liquidity crunches, or trade wars. This may reduce demand for gold as a safe-haven asset and lower gold prices.
## Historical examples of the federal funds rate and the FOMC affecting gold prices
The relationship between the federal funds rate and gold prices is not always clear-cut or consistent. There are many other factors that can influence gold prices, such as supply and demand dynamics, geopolitical events, currency movements, and market sentiment. However, there are some historical examples that illustrate how the federal funds rate and the FOMC can affect gold prices.
• The 1970s: This decade was marked by high inflation, low growth, and geopolitical turmoil. The Fed initially kept the federal funds rate low to stimulate the economy, but this only fueled inflation expectations and weakened the U.S. dollar. Gold prices soared from around $35 an ounce in 1971 to a record high of $850 an ounce in 1980. The Fed then raised the federal funds rate aggressively to fight inflation, reaching a peak of 20% in 1981. This lowered inflation expectations and strengthened the U.S. dollar. Gold prices plunged to around $300 an ounce by 1982.
• The 2000s: This decade was marked by low inflation, strong growth, and financial crisis. The Fed initially kept the federal funds rate low to support the economy after the dot-com bust and the 9/11 attacks, but this created a housing bubble and a credit boom. Gold prices rose from around $250 an ounce in 2001 to around $1,000 an ounce in 2008. The Fed then raised the federal funds rate gradually to cool down the economy, reaching a peak of 5.25% in 2006. This did not prevent the global financial crisis of 2008-2009, which triggered a flight to safety and a surge in demand for gold. Gold prices spiked to over $1,900 an ounce in 2011. The Fed then lowered the federal funds rate to near zero and launched quantitative easing (QE) programs to rescue the economy. This boosted market sentiment and lowered the opportunity cost of holding gold. Gold prices declined to around $1,050 an ounce by 2015.
• The 2010s: This decade was marked by moderate inflation, uneven growth, and trade tensions. The Fed initially kept the federal funds rate near zero and continued its QE programs to support the economy after the global financial crisis. Gold prices rebounded from their lows in 2015 to around $1,350 an ounce in 2016. The Fed then raised the federal funds rate gradually to normalize its monetary policy, reaching a peak of 2.5% in 2018. This increased the opportunity cost of holding gold and weighed on gold prices. Gold prices fell to around $1,200 an ounce by late 2018. The Fed then lowered the federal funds rate three times in 2019 to cushion the economy from trade wars and global slowdowns. This lowered the opportunity cost of holding gold and supported gold prices. Gold prices rose to over $1,500 an ounce by late 2019.
## Conclusion
The federal funds rate and the FOMC are important factors that affect gold prices through their impact on inflation expectations, opportunity cost, and market sentiment. However, they are not the only factors that influence gold prices, and their relationship with gold prices is not always straightforward or stable. Therefore, traders and investors should consider other factors as well when analyzing gold prices and making their trading decisions.