Does a 25 Basis Point Hike Really Matter for Gold?

If there is an interest rate hike in December, it will likely be only a 25 basis point rise. Why should gold investors take care of such a baby step?

This week is relatively quiet and today is a holiday, so we have some time to dig deeper into the potential impact of a possible rate hike in December on the price of gold. Many people ask “why should we care about a rise in federal funds rate by a modest 0.25 percentage points”? What is the difference between practically zero and almost zero?

Indeed, 25 basis points is a piece of cake on an absolute basis. However, economics and finance are not about the absolute, but relative values. The last time when the U.S. central bank raised interest rates was in 2006. Thus, the interest rate hike would be a significant shift in the Fed’s policy of free money. This is why the rise may have important psychological impact on the financial markets.

There are two theories how the Fed’s hike will affect the gold market. According to the first approach, the rise is already priced into the gold market. Therefore, it may be paradoxically positive for the shiny metal if the Fed finally gets it over with. Some historical examples confirm that investors sell the rumor and buy the real hike. Such investors’ behavior may be reinforced by the possible perturbations in the stock or bond markets after the rise.

On the other hand, the hike may signal to the market that short-term interest rates are now on an upward trajectory. Such scenario would be much worse for the gold. Additionally, in contrast to previous tightening cycles, there is an important divergence of policy between the Fed and other central banks. Not to mention $1 trillion of dollar-denominated debt and the unwinding of the carry trade. All these factors will be bullish for the greenback and bearish for the yellow metal.

To sum up, the debate over the impact of the possible Fed hike on the gold market continues. We will be returning to this issue in the following issues of Gold News Monitor. What is certain is that the investors should not underestimate the impact of a small 25 basis point hike on the gold market. It is not the absolute amount that matters, but its psychological effect on markets’ expectations of future path of interest rates.

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Thank you.

Arkadiusz Sieron

Sunshine Profits‘ Gold News Monitor and Market Overview Editor