An Unusual Dynamic: Gold and Treasury Yields Rising Together

Gold broke another intraday record on Monday. This continues the gold bull run that has been ongoing for several weeks.

But there is something else happening that’s quite unusual.

Treasury bond yields are also rising.

As gold was setting records on Monday, yields on the long end of the Treasury curve were also rising. The yield on the 10-year rose 1.23 basis points, closing nearly 3 percent higher. The 30-year yield also spiked higher late in the day.

This is an extremely unusual dynamic.

Typically, rising bond yields create headwinds for gold. Since gold is a non-yielding asset, investors tend to turn to bonds and away from the yellow metal as interest rates rise.  

So, what's going on?

One of the main factors driving gold higher is the expectation of Fed interest rate cuts. On Monday, World Gold Council market analyst Joseph Cavatoni told CNBC that this is “an exciting moment” for gold.

“What’s really driving it is, I think, many market speculators really getting that confidence and comfort [in] the Fed cuts.”

But if everybody expects the Fed to cut rates sooner rather than later, and the inflation monster is dead, why are yields rising on the long end of the curve?

Three possible factors are playing into this unusual scenario.

Inflation Is Alive and Well

First, markets might be figuring out that the inflation monster isn’t really dead.

If you dig under the surface of the most recent CPI reports, it’s clear that price inflation remains sticky.

More significantly, rate cuts and a pivot to looser monetary policy mean more inflation. If the Fed declares victory over inflation now and returns to rate cuts, it’s actually surrendering to inflation. Money creation is the root of price inflation. (Keep in mind that inflation is an increase in the money supply. Rising prices are a symptom of monetary inflation.) And that’s exactly what everybody anticipates the Fed doing, despite the fact that monetary policy still isn’t tight.

Perhaps some people in the markets are waking up to reality.

And that reality is the Fed hasn’t done enough to slay price inflation. It has just raised rates high enough to break things in this debt-riddled economy.

If the markets are realizing that the long-term inflation outlook isn’t as rosy as the Fed wants us to believe, it would make sense for yields on the long end of the Treasury curve to rise in anticipation of higher inflation.

There Are Big Problems in the Treasury Market

Rising yields might also reflect big supply and demand problems in the bond market.

The U.S. Treasury Department is selling bonds into the market at a torrid pace. The Treasury has to keep borrowing money because the federal government is running massive deficits month after month.

The question is how many more Treasuries can the global market absorb?

As the supply of Treasuries rises and demand lags, prices fall. Bond yields are inversely correlated with bond prices. That means interest rates will continue to rise unless demand for bonds increases, or the Treasury quits borrowing money.

Rising bond yields despite the promise of rate cuts almost certainly reflect these Treasury market dynamics.

And the dirty little secret is the Fed can’t tackle this problem with rate cuts alone. To tip the bond market in a more favorable direction, it will need to return to quantitative easing (QE). (Bond-buying with money created out of thin air.)

Typically, the Federal Reserve has its big fat thumb on the bond market, either running QE or at least keeping its bond holdings steady by replacing maturing Treasuries with new bonds bought on the open market. But during the tightening cycle, the Fed has been shedding Treasuries from its balance sheet. This effectively removed artificial Fed demand from the marketplace, putting more upward pressure on yields.

Fed officials must know the Treasury is in trouble. The U.S. government is already paying more for interest expense than it is for national defense on a monthly basis. This is almost certainly why the Fed is considering rolling back balance sheet reduction although most of the assets added to the balance sheet during the pandemic are still there. (Along with most of those added during the Great Recession for that matter.)

Unless the federal government gets its spending problem under control and/or the Fed steps in, the supply of Treasuries will continue to strain the market and drive yields higher. Bond yields are reflecting this ugly reality.

Has the West Lost Its Power to Set the Gold Price?

Even if investors in the West believe the Fed beat inflation, that the central bank is about to cut rates, and the economy will glide to a soft landing, they aren’t the only players in the gold market. Eastern gold buying -- particularly by China -- is an increasingly powerful force in the global market. And gold buyers in the East are likely responding to different dynamics, particularly the drive toward de-dollarization.

In a recent interview, Franco-Nevada Chairman Emeritus Pierre Lassonde warned that the West is losing its pricing power in the gold market. That privilege has shifted East.

"The world hasn't woken up yet. The marginal buyer of gold is no longer the U.S. It's no longer Europe. It's China. Between the country's central bank and the Chinese public, China takes up over two-thirds of all the annual production. They are the new marginal buyer. That's where the gold price is set."

If Chinese and other Eastern investors wary of Treasuries and other dollar-denominated assets are buying a lot of gold and spurning U.S. bonds, this would support the price no matter what Western buyers are doing. This would account for simultaneously rising Treasury yields (as demand falls) and rising gold prices (as demand rises).