In normal times, central banks influence the economy via short-term interest rates. However, since the Great Recession short-term interest rates are near zero. This is why central banks implemented unconventional tools, such as quantitative easing or forward guidance, to influence the economy via long-term interest rates (the first one was the Bank of Japan which adopted it in the context of ZIRP in 1999). This is how forward guidance works. Since the level of long-term rates depends on the expected path of future short-term interest rates, communication about the path of future policy interest rates can affect long-term interest rates.
The best examples of forward guidance are the Fed’s statement from December 2008, when the central bankers stated: “weak economic conditions are likely to warrant exceptionally low levels of the federal funds rate for some time”, and the ECB’s statement from July 2013, when the Governing Council communicated that it: “expects the key ECB interest rates to remain at present or lower levels for an extended period of time”.
Forward Guidance and Gold
Forward guidance is a useful tool in the central banks’ toolkit. It has several limitations, but it generally helps to influence the economy. The greater ability of central banks to shape market expectations and thus present economic conditions increases their credibility and lowers the safe-haven demand for gold.
Moreover, forward guidance significantly affects the gold market. Since the Great Recession, investors have become obsessed with central banks’ communication. They also started to very carefully analyze how economic news may affect the Fed’s stance. Therefore, the price of gold has recently been very dependent on the market odds of a Fed hike and certain economic data which may significantly influence the Fed, such as payroll reports. It was clearly seen in 2015, when practically every release of the jobs report was taken as crucial for the Fed to decide whether the economy was ready for an interest rate hike.
We encourage you to learn more about the gold market – not only about how it is affected by forward guidance, but also how to successfully use gold as an investment and how to profitably trade it. A great way to start is to sign up for our gold newsletter today. It’s free and if you don’t like it, you can easily unsubscribe.