Yes, you read that right! Its rate cuts!! Even though the Fed is at an all out war with this “transitory inflation” as they call it. But in this article, instead of focusing on rate hikes we will focus on federal rate cuts and will try to understand their relation with gold.
FOMC (Federal Open Market Committee) meeting days are always interesting to track. Since the volumes and the volatility are higher on these days, traders get the momentum on both ends. But does all this interest rate volatility impact the gold prices?
Well, To understand this interesting relationship we first need to understand the relationship between Gold and the dollar.
Dollar and the Gold Market Correlation
Now, you are probably wondering, “why are we focusing on dollar?” Because fed rate decisions impact the currency a lot. Since Gold internationally is denominated in Dollar terms, therefore the Dollar prices become one of the key driving forces for Gold market pricing. Therefore any large-wide changes in the Dollar would impact the prices of all the dollar-denominated assets including Gold.
Let us understand the relationship between Dollar and Gold
In general Dollar and Gold share a negative correlation which means that both of them tend to move in opposite directions. If the Dollar moves up, then the Gold prices would fall and vice versa. The same concept has been highlighted in the chart attached below.
Now that we know that, both of these assets share a negative correlation, then let us move ahead and understand the impact of fed rate cuts. To simplify our calculations we will only take those days into account wherein we saw a rate hike of 75 basis points or more, that too after the infamous y2k. Firstly we thought of including the 50 bps rate cuts as well, but the data got pretty large and explaining all of them would have made the article too long.
In the table given below, you will find the data for all the fed rate cuts from 2000 to the current year. Do note that the 50 bps rate cuts have been added in the table only for reference purposes.
|Year||Rate Cut(in bps)|
|Jan 3- 2001||50|
|Jan 31- 2001||50|
|March 20- 2001||50|
|April 18- 2001||50|
|May 15- 2001||50|
|Sep 17- 2001||50|
|Oct 2- 2001||50|
|Nov 6- 2001||50|
|Nov 6- 2002||50|
|Sep 18- 2007||50|
|Jan 22- 2008||75|
|Jan 30- 2008||50|
|Mar 18- 2008||75|
|Oct 8- 2008||50|
|Oct 29- 2008||50|
|Dec 16- 2008||100|
|Mar 3- 2020||150|
|Mar 16- 2020||100|
Why is a rate cut bullish for Gold?
This is because a rate cut makes a currency(i.e. dollar in our case) weaker. This is why you’ll see that whenever the market expects a rate cut, DXY i.e. the Dollar Index starts to fall down. And since the dollar and gold prices have a negative correlation, the gold prices starts to move up in a staggered manner.
So, now that we have understood the entire scenario let us check what happened on the days of rate cuts. The table below contains the data, certain approximations have been done to arrive at the data.
|Year||Impact on DXY||Impact Gold|
|Jan 22- 2008||-1.1%||+3.40%|
|March 18- 2008||+0.60%||-2.08%|
|Dec 16- 2008||-2.16%||+2.37%|
|Mar 3- 2020||-0.45%||+3.41%|
|Mar 16- 2020||-0.69%||-3%|
With this limited data, we can easily see that 3 out of 5 times the negative correlation theory of DXY and Gold played out! But does it mean that it will work everytime and with every single rate cut? No! While conducting the research we found out that this theory did not work out many times when the rate cut was between 25-50bps.
So what is the bottomline?
One cannot simply buy Gold just because a rate cut has happened. The market is driven by lots of forces, rate cuts are just one of them. Also adding to this, often when a 50 bps cut was done by the fed the market already discounted the news. This means that investors and traders usually play out the entire move in advance and build their positions accordingly. The day on which the rate cut is done is just a mere reaction to a thing that everyone in the market already expected. The fun builds up when the fed does something which was not expected by the market.
Long story short It can be said that when it comes to trading fed movements everyone revisits the famous quote, “Buy the rumor and Sell the fact”
Authored by:- Shivank Goswami
Check out the Gold Rates:- https://www.goldlane.in/rate/