The bond market is finally paying attention to the 21 months (and counting) of ongoing rate hikes engineered by the world’s most powerful central bank. It took a while, but the Fed seems to have grabbed the attention of the fixed-income set to a degree that’s more than transitory. Maybe. But if the aura of higher short rates is beginning to take a toll on the long end, the gold market looks inclined to stay skeptical on what it all means.
The 10-year Treasury yield closed Monday’s session at 4.87%, the highest in about two years. It remains to be seen whether the old highs from 2004 will hold. But for the moment, the bond market’s inclined to sell, which translates into higher yields. The Fed, in sum, can claim a modicum of success in modifying expectations. Whether the trend lasts beyond the week is the operative question.
In theory, when and if the bond market throws in the towel and dumps debt securities in earnest, the war over inflation perceptions may be won. Higher long rates, after all, will do what ratcheting up rates on the short end can’t, namely, convince Joe Sixpack that borrowing is going to become more costly and saving offers more exciting financial rewards. Fed Chairman Ben Bernanke wouldn’t mind more of that brand of revised thinking these days, albeit in modest doses so as to sidestep a full-blown recession. A fine line as always, but that doesn’t stop the Fed from trying.
But if all works according to the central bank’s plan, it all adds up to lessening upward momentum on prices, real estate prices in particular. If consumers perceive that mortgage rates are indeed headed materially higher, courtesy of rising long rates, they may be inspired to look elsewhere for financial nirvana.
Arguably, that change of sentiment may encourage those who otherwise lose sleep when pondering the future course of inflation. But the gold market–which has a long history of representing the leading edge of thinking among inflation hawks–looks anything but encouraged these days. In fact, the goldbugs are becoming increasingly anxious even as long yields rise to highs not seen in several years.
The price of gold at one point yesterday traded above $590 an ounce before closing Monday at around $588 in New York. That’s up nearly $40 in just seven trading sessions. What’s more, $600 for an ounce may be just a few sessions away. You have to go back a generation to find the precious metal trading at such heights.
What’s going on? David Gitlitz, chief economist at TrendMacrolytics, argues in a letter to clients yesterday, that gold’s rally at the moment is less a referendum on the Fed’s monetary policy than a reflection of a broad-based rally in commodities. “If that’s the case,” he opines, “it could be setting up a substantial downside correction [for gold] when the Fed finally reaches equilibrium [regarding interest rates] and dollar demand is enhanced along with confidence in the currency.”
In any case, Hedge funds are reportedly jumping on the bandwagon, adding muscle to the already hefty momentum in gold. Meanwhile, there’s the long-running argument that the U.S. twin deficits on the budget and trade ledgers continue to raise fears that the U.S. dollar’s headed lower, which would be a boon to gold. Gold and the dollar share a long history of negative correlation–when one rises, the other falls.
In fact, the dollar’s showing some signs of weakness over the past weak, even as the 10-year Treasury yield rises. One might expect that higher long yields in dollar-denominated instruments would boost the greenback. But for the moment, Mr. Market sees fit to sell the buck. The U.S. Dollar Index fell to 89.45 yesterday, near its lowest levels in about two weeks.
The determining factor that forces one side or the other to blink will ultimately be one decided on the matter of inflation perceptions. As such, the operative remains: Has the Fed convinced the marketplace that inflation’s under control? The case for answering in the affirmative grows a bit stronger if long yields keep rising. Goldbugs, however, aren’t convinced yet. Then again, the bond market has a history in recent years of reversing course just when it looks like yields are ready to spike higher.
Fear and greed, greed and fear.