On May 1, 2019, the attention of businessmen, investors and analysts all around the world was focused on the main financial event of the month: the meeting of the US Federal Open Market Committee (FOMC*) – a branch of the Federal Reserve System (the FED).
Why is this event so important for the global economy? How will the meeting’s outcome affect the price of gold?
What does the Fed do?
The Federal Reserve System, aka the Fed, is the independent agency that acts as the central bank of the United States. The organization implements monetary policy and oversees the country’s commercial banking system.
One of the main tasks of the Fed is to maintain economic stability, preventing outbreaks of crises. In some circumstances, the growth rate of the economy needs to be accelerated. In others, it is necessary to slow down the rapid development in order to avoid inflation and reduce the risk of oversupply.
In the photo: the headquarters of the Fed in Washington.
The Fed regulates economic processes by changing the base interest rate. The organization’s responsibilities include the emission* of dollars. The US banks borrow dollars from the Fed to replenish their reserves. The interest rate determines the costs of such loans for the country's banking sector, impacting the rate of national currency. Decisions on rate changes are made during the meetings of the Federal Open Market Committee that are held eight times a year.
The lowering of interest rates cheapens the national currency. As a result, the demand for dollars increases within the banking sphere, and loans for the public and enterprises are becoming more affordable. A massive infusion of funds into businesses increases production rate. However, the abuse of such method can overheat the economy, resulting in high inflation.
Raising interest rates makes the dollar more expensive, cooling down the already warmed-up economy and reducing inflation.
A rate hike usually serves as a deterrent to gold. If the rate drops, gold shows a positive trend, strengthening against the background of the weakening dollar.
How does the Fed affect the global economy?
The US economy is the largest in the world, and the dollar is the generally recognized reserve currency. This means that the Fed's policy has a direct impact on the global economy.
The US interest rate affects not only the dollar’s market price, but also other currencies, as well as stocks, precious metals and other assets. Even the rumors and forecasts of analysts regarding the upcoming decisions of the Fed provoke changes in the global market.
On the map: the structure of the Fed, consisting of 12 Federal Reserve banks, the Board of Governors and the Federal Open Market Committee.
What is the final decision this time?
On May 1, the Fed announced its decision to leave the interest rate unchanged, ranging from 2,25% to 2,5% per annum. A similar decision was made at the previous meeting in March.
Last year, the Fed raised interest rates four times, thus contributing to the strengthening of the dollar while putting pressure on other financial assets. The refusal of the rate increase in the first quarter of 2019 indicates a softening of the US monetary policy. It can be a powerful impetus, facilitating an increase in the price of gold, meanwhile the dollar begins to lose ground.
What awaits gold?
The Fed’s decision on not raising interest rates is a good sign for gold. In the run-up to the meeting, the outcome of which was quite predictable, the price of gold skyrocketed. The forecasts indicate that this year’s rate hike is not expected to occur. Such news may have a positive impact on the dynamics of the gold market.
On May 7, 2019, the price of an ounce of gold is $1,282.
The latest data provided by the World Gold Council* speaks in favor of gold, demonstrating a growing demand in the first quarter of 2019 that increased by 7% compared with the same period last year. Mass purchases made by central banks of leading countries and a surge of interest among investors reinforce the status of gold.
In the chart: the rise in demand for gold in the first quarter of 2019 compared with previous years.
During economic instability, heads of state, entrepreneurs and ordinary citizens buy gold to strengthen Financial Security. The reliability and stability of gold make it an ideal insurance against the crisis.
*FOMC (the Federal Open Market Committee) — a committee within the Federal Reserve System that oversees the unemployment rate, international trade, price stability and trade of government securities in the United States.
*Emission — the process of introducing money into circulation.
*The World Gold Council — the market development organization, founded by the world's leading gold producers to stimulate demand for gold.