Why does the Fed's rate cut affect the gold market?

World gold prices have slowed down as investors eagerly await the upcoming monetary policy decision of the US Federal Reserve (FED). The FED's interest rate cut has not only attracted attention in the US but also global investors are interested in this move.

The size of the first cut and the overall level of easing remain subject to debate, while the upcoming US election is another complicating factor for investors and global central bankers looking to the Fed for guidance and hoping for a “soft landing” of the economy, meaning falling inflation but not a recession.

US Federal Reserve Chairman Jerome Powell. Photo: Reuters

“ We don’t know yet what this cycle will look like – whether it will be like 1995 when it was just a 75 basis point cut or like 2007-08 when it was a 500 basis point cut ,” said Kenneth Broux, head of corporate, FX and interest rates research at Societe Generale.

Here are some highlights for global markets:

Gold price benefit

In commodities, precious metals and base metals like copper will benefit from the Fed’s rate cut. For these commodities, the demand outlook and a “soft landing” are key.

Lower interest rates and a weaker dollar, which not only reduce the opportunity cost of holding metals, but also make it cheaper for those using other currencies to buy metals, could boost growth.

Lower interest rates will increase gold prices. Photo: PC

“ High interest rates are a key headwind for base metals, causing significant negative physical demand distortions due to inventory sell-offs and putting pressure on capital-intensive end-demand segments, ” said MUFG’s Ehsan Khoman.

When the real thing happens, that is, when the gold price reaches the predicted high, they sell it to make a profit (sell the truth). In other words, the gold price may not maintain its record high for long if speculators decide to dump their holdings when the price reaches the peak they wanted.

In addition to precious metals, base metals such as copper are also benefiting. Lower interest rates and a potentially weaker US dollar make the metal more affordable, helping to boost demand. “ High interest rates are a major headwind for base metals, putting significant demand pressure on them, ” said Ehsan Khoman.

Stock market recovery

Global stock markets have recently been hit by concerns about growth, with stocks falling more than 6% in the first three days of August 2024, following weak US jobs data.

However, the market will recover if lower US interest rates boost economic activity and avoid a recession.

Stock markets were always volatile after the central bank's first rate cut, said Emmanuel Cau, head of European equity strategy at Barclays, raising doubts about the rationale for the move.

But if there is a cut without a recession, the market tends to bounce back. Barclays said that the sectors that will benefit from low interest rates are real estate and utilities.

The soft landing of the US economy has also benefited Asian markets by creating a more stable environment for other economies. Japan's Nikkei 225 has fallen more than 10% since its record high in July 2024 due to the yen and rising interest rates in Japan.

The USD will hardly fall deeply.

Economies may be disappointed by the rise in the value of their currencies as the dollar weakens as the US cuts interest rates. JPMorgan points out that in three of the last four easing cycles, the dollar actually strengthened.

Because the outlook for the USD depends largely on the relative level of US interest rates relative to those of other countries, if US interest rates are higher than those of other countries, the USD tends to become more attractive to investors and vice versa.

The US interest rate cut will weaken the USD further. Photo: Reuters

The yen and Swiss franc are considered safe haven currencies. However, according to a Reuters survey, the interest rate differential between the US and these two countries could halve by the end of 2025. That means these two currencies could become less attractive, making investors continue to consider holding the dollar.

The British pound (GBP) and the Australian dollar may only have a relatively small interest rate differential, meaning that even if interest rates in both countries are slightly higher than in the US, it is not large enough to make the two currencies significantly more attractive than the USD. Therefore, the USD will continue to be attractive to international investors unless the US has really low interest rates.

Against this backdrop, Asian economies were “ahead of the market” in anticipating a US rate cut, leading to many currencies such as the Korean won, Thai baht and Malaysian ringgit appreciating in July and August. The yuan has also recovered its losses against the USD since the beginning of the year. This suggests that Asian markets have reacted positively to expectations of a US rate cut, increasing the value of their currencies against the USD.

"Leading" central banks to lower interest rates

In the spring, when U.S. inflation was higher than expected, concerns arose that the Fed would keep interest rates on hold all year. In this scenario, institutions such as the European Central Bank (ECB) or the Bank of Canada would have a difficult choice whether to lower interest rates to stimulate the economy.

But now that the Fed has begun to act, it will make it easier for other developed-world central banks to weigh monetary policy. Traders are predicting other central banks will follow suit. However, the ECB and the Bank of England are likely to cut less than the Fed because they remain wary of inflation.

Global bond markets have also benefited, as they typically follow U.S. Treasury yields. U.S., German and British government bond yields are all headed for their first quarterly decline since late 2023, as the Fed nears its September 18 rate cut. That means bond prices are rising.

In addition, lower US interest rates could give emerging market central banks more room to adjust and support domestic growth, as the pressure to keep interest rates high to stem capital outflows and protect exchange rates would be less with lower US interest rates.

From there, they can cut interest rates to stimulate domestic consumption and investment. About half of the 18 emerging markets surveyed by Reuters The watchdog has begun cutting interest rates this cycle, led by Latin American and European countries.

However, the volatility and uncertainty surrounding the US presidential election is a challenge. Ms. Trang Nguyen, global head of emerging market credit strategy at BNP Paribas, assessed that the election will have a big impact, actually complicating the rate-cutting cycle. "We may see more ad hoc actions among central banks around this event," she predicted.

Source: https://congthuong.vn/tai-sao-viec-cat-giam-lai-suat-cua-fed-lai-anh-huong-den-thi-truong-vang-346711.html