Gold Recovers as Real Treasury Yields Fall Amid US Inflation Data

What happened

Gold showed resilience and rebounded in the latter part of last week, even after the release of US inflation data that exceeded expectations. The main driver behind this recovery was a fall in real yields, which are influenced by nominal bond yields and inflation expectations. Inflation expectations remained largely unchanged, supported by persistently elevated energy prices and a not-so-hawkish stance from the Federal Reserve. On the other hand, nominal Treasury yields dropped following the inflation data, accompanied by growth-sensitive assets like stocks and copper, which may signal growing concerns about an economic slowdown.

Why it matters

The dynamic between inflation, nominal yields, and real yields is crucial for gold. When real yields fall, the opportunity cost of holding gold (which pays no interest) decreases, making it more attractive. The decline in nominal yields in a scenario of persistent inflation and stable inflation expectations resulted in a reduction of real yields. This movement, combined with the decline in other growth-sensitive assets, suggests that the market may be pricing in a scenario of economic growth concerns, which historically favors gold as a safe haven.

Market impact

• Interest rates and bonds: The fall in nominal Treasury yields, especially in a high-inflation environment, points to a potential pricing in of an economic slowdown. This could lead to a flatter yield curve or even an inversion in some segments, reflecting expectations of lower growth and, potentially, future more dovish actions by the Fed.
• Dollar and exchange rates: A scenario of growth concerns in the US, leading to falling real yields, tends to weaken the dollar. This occurs because the reduced attractiveness of dollar-denominated assets, due to lower real yields, can decrease demand for the currency. In Brazil, a globally weaker dollar would tend to ease upward pressure on the real.
• Equities: The decline in nominal yields and the perception of growth concerns can put pressure on equity markets, especially cyclical sectors sensitive to economic activity. Higher-risk assets tend to suffer in lower-growth scenarios.
• Commodities: Copper, an industrial commodity sensitive to global growth, has already shown signs of decline, reinforcing the reading of economic concerns. Gold, on the other hand, tends to benefit as a safe haven, which explains its recovery.
• Gold: Gold's recovery is a direct reflection of the fall in real yields. If growth concerns persist or intensify, gold tends to remain a sought-after asset, driving its price higher.

What to watch

The next key catalyst to watch will be the US Flash PMIs data, due on Friday. Additionally, on Thursday, the latest US Jobless Claims figures will be released. This data will provide further clarity on the health of the American economy and the extent of growth concerns.

Scenarios

Base Scenario: If US Flash PMIs surprise to the downside, growth concerns might increase, leading to a more dovish repricing further out the curve and further boosting gold due to falling real yields. Risk Scenario: A stronger-than-expected reading in the Flash PMIs could quell growth fears, which would tend to reverse the fall in real yields and, consequently, drag the price of gold down again.

Original source: ForexLive (InvestingLive). For information only, not investment advice.