The Fed’s inaction in September was supportive for the price of gold. Why?

The price of gold rebounded last week, after the U.S. central bank’s decision to keep interest rates unchanged. Why? Well, the most common explanation is that holding interest rates ultra-low supports the non-interest bearing asset due to the low opportunity cost of investing in gold. Thus, the Fed’s announcement that it will not be raising interest rates was positive for the shiny metal. However, this is only part of a story. The U.S. central bank has been inactive for years, but gold was not gaining following every FOMC meeting. For example, the price of yellow metal dipped following July’s FOMC meeting. Gold has fallen more than 4 percent since the beginning of the year.

What was different this time was that investors took the Fed’s announcement as a no-confidence vote for the U.S. economy. Just as a reminder, the central bankers cut their GDP growth forecasts in 2016 and 2017, as well as the median federal fund rate projections. And because the decision came after the sell-off in the stock market due to developments in China, the Fed’s inaction was interpreted as a signal that the global economy remains vulnerable and the financial conditions are worse than recent headlines suggest. In this way, the central bankers added to fear and uncertainty.

Moreover, the Fed is a source of financial instability, because it creates great uncertainty about the future path of interest rates and its policy. The discussion when and by how much the Fed would raise short-term interest rates has become the biggest concern in the last couple of months.

Last but not least, the Fed’s interest rate policy is essentially price control, which removes important information from the market, causes a misallocation of resources and destabilizes the whole economy, as the interest rate is probably the most important price in the market economy. So should anyone be surprised that there is no honest pricing of assets anywhere on the planet? And Yellen, the Chairwoman of the central planners, at a recent press conference, did not rule out the possibility that the Fed would never end its zero interest rate policy. Never! It should not be surprising now that the uncertainty rose after the FOMC’s last meeting, stocks fell and gold rose.

Summing up, the FOMC added to global uncertainty. Keeping interest rates unchanged was interpreted as a no-confidence for U.S. economic health. Additionally, the Fed creates volatility and instability due to uncertainty about the future path of interest rates. This is why the U.S. central bank’s inaction is a supportive factor for the price of gold right now, but renewed U.S. rate hike hopes may put the shiny metal under downward pressure.

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Arkadiusz Sieron
Sunshine Profits‘ Gold News Monitor and Market Overview Editor

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