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How did gold perform during the Fed rate-hike cycles?

18:05, 18 March 2022

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  • Gold
    Gold
    1712.18 USD
    -3.71 -0.220%

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Gold bars on US dollar bill banknotes
Gold bars on US dollar bill banknotes – Photo: Shutterstock

Following weeks of decline due to optimism around negotiations between Russia and Ukraine, gold reacted positively to the most recent major central bank announcements, which indicated tighter policies as well as increased risks to the economic forecast.

The Federal Reserve (Fed) formally began a new rate hike cycle on March 16, 2022, lifting interest rates by 0.25 percent for the first time since November 2018 and pledging six more hikes (one at each meeting) by the end of the year due to continued inflationary pressures.

The next day, the Bank of England raised the Bank Rate from 0.5% to 0.75%, its third straight increase since December. A week earlier, also the ECB also moved in actions, by quickening the pace of tapering, and in words, by promising a more data-dependent approach while not ruling out a rate hike this year.

The biggest central banks have marked a watershed moment, recognising that the ultra-expansionary monetary policies that defined the post-Great Financial Crisis decade are no longer appropriate at this new macroeconomic juncture.

What effect might this historical shift in monetary policy have on gold's performance? How did the precious metal do during prior Fed’s hiking cycles?

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Are interest rates on the verge of reversing their secular decline?

historical US interest ratesHistorical Fed Funds rate – Credit: Koyfin

Gold and interest-rate hikes: Experts' view

  • State Street Global Advisors' gold expert George Milling-Stanley believes the price of gold will hit a new high this year, since Fed Chairman Jerome Powell has said that the Fed would increase rates cautiously in order to avoid causing a US recession. "History implies that the gold price typically rises concurrently with interest rate hikes," as occurred between December 2015 and December 2018, as well as between June 2004 and June 2006, according to the expert.
     
  • "Returning interest rates to more normal levels would most certainly result in a major recession in the US economy," according to a recent Degussa Economic Market report. That is probably too much for central bankers to tolerate, therefore they would likely allow their currency to depreciate. Despite raising short-term interest rates, economists at Degussa believe that central banks are unlikely to decrease high inflation to around 2% anytime soon. Owning some physical gold and silver is a long-term oriented investor's option for safeguarding an investment portfolio from inflation risks since precious metals cannot be debased by central banks' monetary policies, the report concluded.
     
  • According to MKS Pamp Group, a 60-year old precious metals trading company, the macro background has shifted dramatically. The impending Fed rate rises, intended to combat energy-induced price inflation, will accelerate the danger of recession far more than markets previously expected. The crisis in Ukraine has intensified a stagflationary background that supports gold, with the possibility of a European recession mounting. The average gold projection for 2022 has been raised to $2,000/oz (up from $1,800/oz previously), with an upside risk of $2,500/oz and a downside risk of $1,600/oz (up from $1,400 previously).
     
  • The deepening of the Russia-Ukraine crisis and the tightening of Western sanctions against Russia have increased the possibility of stagflation (stagnant growth and increasing inflation), Rajat Bhattacharya, Standard Chartered's Senior Investment Strategist, said in a recent note. According to the expert, there is a greater probability of inflation being higher for a longer period of time, forcing the Fed to act. However, if there are signs that growth is slowing down, the Fed is likely to shift its attention to supporting the economy and the job market. Gold and energy assets have done well this year in the face of increased inflation threats; they continue to be recommended by the analyst for hedging against additional inflation.

Gold vs USD: Hiking cycles performance 

a table showing the performance of US dollar and Gold during Fed rate-hike cycles performance of US dollar and gold during Fed rate-hike cycles since 1970 – Credit: Capital.com / Data: Tradingview

Gold performed well when the Federal Reserve hiked interest rates, with an average performance of 25.8% over the hiking cycle, but with a relatively high standard deviation of 53%. However, these figures are substantially influenced by gold's astonishing performance throughout the rate hike cycles of the 1970s.

Gold

1,712.18 Price
-0.220% 1D Chg, %
Long position overnight fee -0.0052%
Short position overnight fee 0.0019%
Overnight fee time 21:00 (UTC)
Spread 0.18

Natural Gas

7.14 Price
+0.880% 1D Chg, %
Long position overnight fee -0.1719%
Short position overnight fee 0.1271%
Overnight fee time 21:00 (UTC)
Spread 0.005

Oil - Brent

92.75 Price
-0.630% 1D Chg, %
Long position overnight fee 0.0469%
Short position overnight fee -0.0721%
Overnight fee time 21:00 (UTC)
Spread 0.04

Oil - Crude

87.05 Price
-0.570% 1D Chg, %
Long position overnight fee 0.0242%
Short position overnight fee -0.0436%
Overnight fee time 21:00 (UTC)
Spread 0.03

When the analysis is limited to post-1980 rate rise cycles, the average gold performance falls to 6.5%, and the standard deviation drops to 27%.

On average, a rate-hike cycle of the Federal reserve lasts 16 months and deliver a 4.6% average percentage point increase in interest rates. Since 1983, hiking cycles have been longer, but interest rate rises have been less pronounced (2.7 percentange points increase on average).

Only once, between August 1980 and December 1980, did the Fed truly manage to cut the inflation rate during the period. On average, the inflation rate changes by 1.4 percentage points during the rate-hike cycle. Changes in the 10-year Treasury yields showed a similar pattern.

In comparison, the US dollar index (DXY) has delivered an negative average performance of (-1.6%) since 1970 and a positive average performance of 2.3% after 1980. The standard deviation is much lower than the one of gold. 

There is a substantial negative correlation between gold and dollar performance during Fed hike cycles. Except for two cycles between March 1974 and June 1974 and July 1999 and June 2000, gold did better when the dollar fell and vice-versa.

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