Recent developments in the world’s financial markets have challenged long-held assumptions and beliefs. Gold prices customarily rise in times of war and conflict, but this time around they have fallen.
In order to understand why, we must look at interest rates. War tends to drive up the prices of energy and certain commodities, prompting the US Federal Reserve to raise interest rates to contain inflation. Higher rates strengthen the dollar and increase demand for it.
But unlike the dollar, gold does not generate a yield. Gold is also globally priced in dollars, meaning that when the dollar strengthens, the cost of gold goes up in other currencies, lowering the demand for it.
The demand for gold is often driven by the fears that accompany the outbreak of wars and crises. When those fears subside, demand naturally declines. During periods of tension, creditors’ demand for liquidity increases. Since gold holdings can readily be converted into cash, this generates greater supply and lower prices.
Likewise, at times of crisis, some central banks try to shore up their currencies against the dollar by selling a portion of their gold reserves. This also increases supply and drives gold prices downwards.
It was once an accepted rule that stock markets would fall when employment figures dropped and unemployment rates rose. But recently markets have often risen instead. Once again, the reason is to be found in interest rates.
Since the 2008 global financial crisis, the financial markets have become heavily dependent on cheap financing. When rises in unemployment raise the spectre of a recession, the Federal Reserve typically cuts interest rates, increasing liquidity and boosting demand for securities.
Moreover, many of today’s most popular financial assets depend less on labour demand than on capital intensity, as is the case with the tech firms that dominate the markets.
In a recent article for Project Syndicate, the British economist Jim O’Neill observes that the US stock market is currently valued at around $77 trillion, which is about half the total value of the global financial markets. Meanwhile, the US share of global GDP stands at around 25 per cent as the centre of gravity of the global economy continues to shift eastwards towards China, India, and the surrounding region.
The question now is whether the US economy will see rapid growth driven by the efficiency and productivity increases associated with artificial intelligence. This is what AI optimists predict, encouraged by a record wave of initial public offerings in the industry and soaring valuations.
Another question is whether the financial markets will undergo waves of correction, bringing them more in line with the realities underlying the present economic shifts. O’Neill reminds us of the harsh correction experienced by the Japanese market, whose capitalisation peaked in the early 1990s at around 45 per cent of the global total. What followed was three and a half decades of decline and stagnation.
Attention in the financial world has been riveted this week on the Federal Reserve’s first interest-rate-setting session under its new chairman Kevin Warsh. While the markets currently expect neither a rate increase nor a cut, the new chairman’s credibility and independence are under scrutiny.
His predecessor, Jerome Powell, was persistently criticised by US President Donald Trump for refusing to lower interest rates. Many are under the impression that Warsh’s loyalty to Trump might lead him to yield to short-term political and economic pressures instead of prioritising market stability and inflation control in the long term.
It should also be borne in mind that, unlike most central banks, the Federal Reserve has been mandated by Congress to maximise employment – in other words to reduce unemployment to the lowest possible level – and to pursue the traditional monetary policy objective of maintaining price stability through low inflation.
Beyond this dual mandate, it is also responsible for ensuring financial stability by supervising the banks and monitoring their financial soundness.
The Federal Reserve is now confronted with a 4.2 per cent inflation rate that was recorded in May. This is the highest level in more than three years and more than double its stated target of two per cent. Inflation stood at 2.4 per cent in February, just before it began to climb in tandem with what is known in the US as the “Iran war effect.”
The current situation does not warrant a rate cut, contrary to Trump’s wishes, especially given the decline in unemployment cited in the latest US labour market report. Consequently, a majority of the Federal Reserve’s monetary policy committee members are likely to vote to hold interest rates unchanged.
If Warsh joins the hold side, as indicated in a recent editorial of the British newspaper the Financial Times, it will signal his independence from Trump and provide him with an opportunity to explain the trends revealed by US inflation and unemployment data.
Warsh has rightfully criticised the excessive reliance of interest-rate decisions on economic data that fail to reflect current conditions in real time. Most often, the data cited describe what has happened, rather than what is taking place or is expected to occur, and it is for this and other reasons that the Federal Reserve has been criticised for reacting too slowly to inflation and mistakenly characterising inflationary waves as temporary or transitory.
As a result, it has failed to take timely action, thereby allowing inflation to persist longer than it should have done.
Meanwhile, the recently released Global Economic Prospects Report produced by the World Bank predicts a sharp slowdown in global growth, which is expected to fall to 2.5 per cent, the lowest level since the Covid-19 pandemic.
Growth in developing countries and the emerging markets is projected to decline to 3.6 per cent, threatening employment opportunities and complicating efforts to achieve development goals in these countries where an estimated 1.2 billion people are expected to enter the labour market in the coming decade.
As crucial as such factors are, they are not decisive in shaping Federal Reserve policy. Nor do financial markets pay them much heed when swept up in the euphoria of momentary booms.
This article also appears in Arabic in Wednesday’s edition of Asharq Al-Awsat.
* A version of this article appears in print in the 18 June, 2026 edition of Al-Ahram Weekly
Short link: