The impact of U.S. interest rates on gold and understanding it requires careful analysis and familiarity with economic concepts. Central banks worldwide, such as the Federal Reserve (the central bank of the United States), use setting interest rates as a tool to control inflation, money circulation in society, loan demand control, and so on. However, it should be noted that changes in the interest rates set by U.S. central banks affect not only the economies of governments like the United States itself but also, on a broader scale, financial markets and human societies.
Interest rates will inevitably be a significant part of your financial life; therefore, lack of familiarity with them especially as an active participant in financial markets can have substantial effects on your trading style and cause missed opportunities or significant financial losses.
What is an Interest Rate?
Simply put, the interest rate is the cost you pay for borrowing money, whether this loan is a student loan, mortgage, or a purchase financing loan, etc. In other words, when you borrow money, you usually have to repay the principal amount plus a percentage of it as interest. There are exceptions, of course: for example, if you pay your credit card balance in full every month, or if you benefit from a promotional zero percent interest rate, you will not need to pay interest.
If lenders and creditors observe your responsible credit behavior and assess you as a low risk borrower, they may offer you a lower interest rate.
The amount of interest you must repay depends on the loan term and whether the interest rate is fixed or variable. In a fixed interest rate, the interest rate does not change throughout the loan term, whereas in a variable interest rate, it depends on a reference rate (called an index). When the index changes, the interest rate may also change.
When interest rates are high, borrowing money becomes more expensive, and when interest rates are low, borrowing money is cheaper. Therefore, before agreeing to a loan or obtaining a new credit card, it is essential to fully understand how the interest rate will affect the total debt amount and your financial costs.
This awareness and precise understanding of interest rates is especially important for financial market participants, as this concept significantly impacts financial and investment decision making.
What Happens When Interest Rates Rise?
Typically, an increase in interest rates is considered an indicator of economic prosperity and confidence. During this time, businesses have higher income and profits, and individuals’ willingness to take out loans and borrow increases. Banks, in order to control and manage these demands, must raise interest rates to keep demand at a controlled level.
In these periods, the attractiveness of safe investments like gold decreases. Additionally, rising interest rates help strengthen the domestic currency because both domestic and foreign investors are more inclined to hold and invest in financial assets with higher returns. This causes demand for gold to decline, and as a result, the price of gold falls in the short term.
Moreover, increasing interest rates is a tool that central banks use to combat inflation. When prices rise rapidly, central banks try to prevent excessive demand and consumption growth by raising interest rates. This action encourages people to save more and avoid purchasing non essential goods, helping to control inflation.
What Happens When Interest Rates Fall?
When interest rates fall, it is usually due to decreased economic confidence or an economic recession. In such conditions, individuals and businesses, facing economic difficulties such as rising living costs, slowed wage growth, and higher unemployment rates, tend to borrow less money. This economic slowdown typically causes the national currency to weaken, as investors seek markets with higher returns.
In this situation, due to low interest rates, investors turn to investing in gold. Because in these circumstances, returns from other assets like stocks or bonds decline, and gold is recognized as a stable asset that is resistant to inflation and economic crises. Additionally, since gold does not generate annual yields, low interest rates mean that other investments will also offer insignificant returns, which leads to increased demand for gold.
The Impact of the Federal Reserve’s Interest Rate on Gold in the United States
Interest rates vary in each country and have different effects on the economy of those countries and the price of gold within them. Interest rates in the United States have a greater impact compared to most countries, and because gold is primarily traded in U.S. dollars, the interest rate in this country has a specific influence on the price of gold. Therefore, when the Federal Reserve of the United States (also known as the Fed) raises interest rates, this can have a profound effect on the price of gold. Typically, with an increase in interest rates, the price of gold decreases, while a reduction in interest rates helps sustain a high price for gold.
For example: imagine you are active in the gold market in 2023. Interest rates in the United States had been rising for a long time, and financial markets were deeply concerned. The Federal Reserve, the U.S. central bank, recently decided to raise the interest rate by another 0.25 percent, and this news attracted everyone’s attention. An increase in interest rates means borrowing money becomes more expensive. Many investors, especially those seeking higher returns from other assets, moved toward other markets such as bonds and stocks. But these changes in interest rates only had a temporary effect.
However, an interesting event occurred: immediately after the announcement of these changes, the price of gold unexpectedly rose. Why? Because when the Federal Reserve raises interest rates, the yields on other investments like bonds increase, which appeals to some investors. Yet gold, as a safe haven, retained its appeal during this turbulent period. Gold does not pay any interest at all, but during times of economic volatility, it resists the depreciation of other assets.
In this situation, when the Federal Reserve raised interest rates, many investors sought refuge in gold. They concluded that gold could still protect against market volatility. As a result, the price of gold rose by up to 2 percent, reaching its highest level in recent months. This change demonstrated that an interest rate increase which usually causes gold prices to fall led to increased demand for gold in this case due to reduced concerns about financial crises.
Other Factors That Cause Changes in U.S. Interest Rates and Their Impact on Gold
With the new understanding you have now gained about financial markets and the Federal Reserve’s role in setting interest rates and their impact on gold, you realize that the Federal Reserve uses interest rates as a control tool for specific regulatory reasons. However, other factors that cause changes and influence interest rates and the gold market include the following:
Economic Growth
When economic growth is rapid and markets stabilize, the Federal Reserve may increase interest rates to prevent the formation of financial bubbles. In this case, gold, known as a safe haven asset, may experience decreased demand as investors move toward markets with higher returns. Conversely, if economic growth slows down, the Federal Reserve may reduce interest rates to prevent a recession, which can lead to increased demand for gold.
Strong U.S. Dollar
When the U.S. dollar strengthens, especially compared to other global currencies, the Federal Reserve may decide to raise interest rates. Typically, rising interest rates cause gold prices to fall, but in this scenario, a stronger dollar can have a different impact on gold. A stronger dollar can reduce demand for gold; however, at times, investors may still seek gold as a safe haven asset due to increased global economic risks, which can lead to rising gold prices.
Low Global Demand for Gold
Sometimes, despite rising interest rates in the United States, a decline in global demand for gold can cause its price to drop. If major gold consuming countries such as China or India face economic recession or experience a decrease in domestic demand for gold, we may see gold prices fall even when U.S. interest rates are rising. In such conditions, low global demand for gold can have a greater impact on gold prices than changes in U.S. interest rates.