Fed Rate Hikes vs Gold: The Real Interest Rate Connection

The US Federal Reserve's interest rate hikes have far-reaching consequences beyond American shores. When the Fed raises rates, it makes borrowing more expensive across the US economy, aiming to cool inflation.

This increase in interest rates also makes US government bonds and fixed deposits more attractive, drawing money towards these interest-bearing assets. As a result, gold, which pays no interest or dividends, becomes less appealing by comparison.

However, this basic principle does not always hold true. During several Fed hiking cycles, including parts of 2022 and 2023, gold held firm or even climbed. The reason is that rate hikes do not happen in isolation.

The relationship between the Fed's rate moves and gold prices depends on real interest rates, the nominal rate minus inflation. If the Fed raises rates by 1% but inflation is running at 5%, the real rate remains deeply negative. In such an environment, holding cash or bonds actually loses you money in purchasing power terms.

Gold, which holds its real value over time, becomes attractive because everything else is eroding. This is why gold surged during 2020-2022 even as nominal rates were rising.