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What US inflation means for bond yields, USD, gold

gold bullion bars stacked together

While the Fed has been peddling the narrative that the lift in US inflation is transitory, the risk is higher US inflation persists longer than expected, because it is driven by supply disruptions, and firmer post-lockdown aggregate demand, says chief macro strategist at PinPoint Macro Analytics, Richard Grace.

Under these economic conditions, the bond market will continue to adjust higher, as will the USD, in anticipation the Fed will lift interest rates sooner than current market pricing of mid to late 2022. Gold prices will remain well-supported, until there is either a notable rise in US yields (generating a fall in real US bond yields), or a significant appreciation of the USD. Market participants need to be assured that inflation is under-control before the gold price trends lower, says Grace.

Higher inflation drives bond yields higher

US CPI inflation rose 0.9% (MoM) significantly more than expected in October, driven by a broad-base of factors. The annual rate of inflation lifted from 5.4% in September to 6.2% in October, to an almost 30 year high. The biggest contributors to inflation in the month were energy, food, shelter, and used vehicles (transport). Core inflation (ex food and energy) also rose more than expected, lifting the annual rate to 4.6%. Supply constraints and the recent lift in US producer prices (PPI wholesale inflation) has been signalling the risk of higher than expected CPI inflation for some time.

The impact of higher-than-expected US inflation drove a lift in US bond yields. Yields lifted right across the curve. Notably, those yields most-sensitive to rising inflation pressures at the long end of the curve, lifted the most, with the 10-year up a large 13bps on the day, to 1.56%. The US 30-year bond yield also rose, partly driven by poor demand in the day’s 30 year treasury auction.

Higher bond yields drive the USD higher

The lift in US bond yields, drove the USD higher. With the USD quite sensitive to higher US bond yields (see charts below). CFTC non-commercial (speculative) positions on the Chicago Mercantile Exchange (CME) have been signalling for quite some time that market participants are anticipating a higher USD. The increase in accumulated long USD positions since mid 2021, has been driven by market participants’ concerns that higher US inflation would generate higher US bond yields and result in a firmer USD.

Gold prices sensitive to higher US inflation, lower US bond yields

The risk (and outcome) of higher US inflation has lifted the demand for gold. Gold is perceived to be a traditional inflation hedge. Gold prices tend to rise when US inflation lifts, and when US inflation lifts enough to lower real (inflation-adjusted) bond yields (see charts below).

Gold prices therefore have an inverse relationship to US real bond yields. In other words, as real US yields go down, the USD gold price goes up. While a firmer USD can at times dampen the gold price, when the catalyst in the market is significantly higher than expected inflation, and a large jump in bond yields, gold prices will react more to that and lift, than they will to a slight firming in the USD. 

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