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Fed Rate Cuts and its relation with Gold?

3 Mins read

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.

Dollar and Gold chart

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.

The data

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.

YearRate Cut(in bps)
Jan 3- 200150
Jan 31- 200150
March 20- 200150
April 18- 200150
May 15- 200150
Sep 17- 200150
Oct 2- 200150
Nov 6- 200150
Nov 6- 200250
Sep 18- 200750
Jan 22- 200875
Jan 30- 200850
Mar 18- 200875
Oct 8- 200850
Oct 29- 200850
Dec 16- 2008100
Mar 3- 2020150
Mar 16- 2020100

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.

YearImpact 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

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About author
Shivank Goswami is an independent Multi-Asset Class Investor and Trader. He specializes in analyzing and trading various derivative markets. His articles are primarily focused on simplifying complex financial market concepts. Lately, he has authored an e-book (available on amazon) titled, 'Hedging Bullion Trades- Why Trade Naked, When you can Hedge?' -Title Contribution by- Ms. Adhishwari Singh (Ma'am) The book explores several ways by using which Bullion Traders can Hedge their Bullion Futures positions that too, without using the Illiquid Options segment.
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