How changes to monetary policy might impact gold's price
You hear quite a bit about the Federal Reserve and changes they've either made or plan to make to the United States' monetary policy. Ultimately, the Fed is charged with maintaining balance in U.S. markets, and to do so, it sets interest rates, manages the money supply and regulates financial markets.
Of course, anything that impacts monetary policy has an impact on investment assets. That leads to questions about the price of gold — and, in particular, the question of how the Federal Reserve's monetary policy changes may impact the price of this precious metal.
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How changes to monetary policy might impact gold's price
Gold is considered a safe haven investment. Investors, central banks and institutions use the precious metal to add stability to their financial holdings. As such, any change the Federal Reserve makes to monetary policy has the potential to send the price of gold up or down. Here's how:
Changes to the target federal funds rate
The most common change the Fed makes to monetary policy is changing the target federal funds rate. This is the rate at which financial institutions lend their reserve balances to other financial institutions overnight on an uncollateralized basis. The fed funds rate is the foundation for interest rates on all loans and returns on assets like deposit accounts and bonds. That has an impact on gold, too.
Frequently, when rates increase, gold generally increases in value, and when the Fed reduces rates, the price of gold tends to stagnate or decline. For example, the Fed has increased its rate more than 10 times since early 2022. During the same time period, gold's price has been growing.
That's largely the result of inflation.
"Gold is an asset that could be used to hedge against inflation," says Peter J. Klein, the founder and Chief Investment Officer of ALINE Wealth. "As inflation decreases the value of currency, gold is a store of value. This is likely why gold prices are up, even in the face of increasing interest rates."
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Changes to the Fed's bond-buying program
When economic conditions are poor and a deflationary period is a concern, the Fed may respond with quantitative easing. This means they purchase bonds and other fixed-income assets. Increasing demand drives returns for these assets down. In turn, interest rates are pressured downward and consumer spending increases.
On the other hand, when inflation levels are high, the Fed takes part in quantitative tightening. This means that when Fed-owned bonds mature, they don't buy new bonds as replacements. This can lead to higher bond rates as bond issuers look to fill the demand the Fed no longer fills.
There's no set rule for how this may impact gold as several factors play a role. One thing we do know is that recently, the impact has been a positive one, with gold rising from around $1,450 per ounce in October 2017, when quantitative tightening started, to around $2,000 per ounce today.
The bottom line
The simple fact is that when the Federal Reserve makes monetary policy changes, those changes don't just impact the dollar, they have an impact on the values of all assets, including gold. However, it's important to keep in mind that rules are made to be broken in the market.
Although quantitative tightening and interest rate hikes typically have an impact on the price of gold, they're not the only factors to consider. You should also pay close attention to drivers like inflation, geopolitical conditions and the overall economy. Considering these factors, hedging your bets with a reasonable dose of gold (5% to 10% of your asset allocation) in your portfolio is a wise decision.
