10-year yields have room to push to 2.5%, what does this mean for gold?
(Kitco News) - Rising bond yields due to improving economic expectations is the biggest near-term threat to the gold market, according to analysts.
The bond market has seen an unprecedented move so far this year, rising to 1.75% last week. While yields have backed down a little, they are still fairly elevated, trading at a one-week low at 1.6%. Bond yields are up more than 200% from the lows seen in August.
With the Federal Reserve taking a relaxed view on the bond market selloff, the question many investors are asking is just how high yields can go. According to some analysts, the bond market has a further downside as economic conditions improve and yields could rise more than 50% from current levels.
There is a growing chorus of economists and market analysts calling for bond yields to push to 2.5% by year-end.
"The passage of the large fiscal stimulus package by the Biden administration suggests that it is both willing, and able, to pursue an extremely loose fiscal stance that will give a major boost to the U.S. economy over the next couple of years," said Thomas Mathews, markets economist at Capital Economics. "Second, it has become clear that the Federal Reserve now sees little need to push back on rising long-term yields, even if this results in somewhat tighter financial conditions."
Capital Economics raised its bond market forecast on Thursday as it now sees the 10-year yield trading between 2.25% and 2.50% by year-end.
Another U.K. research firm, CrossBorder Capital, said they are also bearish on bond prices as they see more supply coming into the market as President Biden pushes an expensive agenda to fight against social and economic inequality, climate change and improve the nation's infrastructure.
"Having suffered from a relative dearth of supply in recent years, bond investors now face an unprecedented surge in new issuance. If history is any guide, with or without Fed buying, U.S. bond yields should rise sharply. And, despite Central Bank promises to maintain low or near-zero policy rates, the benchmark 10-year U.S. Treasury note looks set to test 2-2½% yields, with the yield curve steepening sharply," analysts at CrossBorder Capital said in a report Wednesday.
CrossBorder Capital added that in the current market environment, a proposed Federal Reserve yield curve control program would likely fail to cap bond yields.
"The lingering hopes of many bullish fixed income managers are pinned on the Federal Reserve adopting some form of yield curve control (YCC) to contain rising term premia and stop long-dated yields from rising further. We have argued before that this is a big ask," the analysts said. "Although we accept that the supply of Treasuries may dip as a result, the other side to this policy is a large increase in liquidity. The net effect of this liquidity is to increase investors' risk appetite and so reduce their demands to hold 'safe' assets, such as Treasuries. Therefore, although the supply of Treasuries to the private sector may fall, it is more than offset by a collapse in the demand for Treasuries, and hence results in lower bond prices."
The 10-year bond market has been attracting most investor attention as it is expected to rise faster than short-term and medium-term bonds. Although the yield curve is expected to steepen, economists at CIBC said Thursday that investors should pay attention to the belly of the curve – five-year bond yields.
Economists at CIBC said that they see room for five-year yields to push higher.
"We could easily see five-year Treasury yields edging higher as the market gains confidence in the pace of recovery ahead, not due to inflation fears, but simply on expectations that short-term policy rates will be normalized in the next half-decade," the analysts said.
Rising bond yields hurt gold on two fronts
Not only do rising bond yields hurt gold prices because it raises the precious metals holding costs as a nonyielding asset, but it also provides momentum for the U.S. dollar.
The gold market is priced in the U.S. dollar, so the stronger the greenback, the more expensive the precious metal becomes.
The U.S. dollar fell more than 8% in the last year as the world has had to deal with the crippling effects of the COVID-19 pandemic; however, with the rising bond yields and improving economic conditions, many market analysts are starting to become bullish on the greenback.
Hussein Sayed, chief market strategist at FXTM, said that the expectations of rising government debt as trillions of dollars are pumped into financial markets to support the economy are no longer scaring currency investors.
"With the dollar now sitting at a four-month high against a basket of its peers, the popular view of a weaker U.S. currency is now being put to a big test," he said. "The dollar index has just breached its 200-day moving average for the first time since May 2020. If it manages to hold above this long-term moving average for a couple of days, it will provide more signals to continue its advance. While higher debt levels should be considered a negative factor for a currency, investors are instead focusing on growth expectations."
With both bond yields and the U.S. dollar expected to move higher, where does this leave gold prices?
Gold prices are down about 11% from their highs seen at the start of the year. The market continues to struggle to attract new capital as prices appear to be stuck below $1,750 an ounce. June gold futures last traded at $1,735.50 an ounce, relatively unchanged on the day.
Many major banks are starting to revise their gold price forecasts as optimism for a robust economic recovery continues to grow.
Credit Suisse is the latest bank to downgrade its gold forecast. The Swiss bank now sees gold prices averaging the year around $1,900 an ounce, down from their previous forecast of $2,100. They also see lower gold prices in 2022, with gold averaging around $2,100 next year, down from the previous forecast of $2,300.
"We think near-term gold prices could remain under pressure from a rising TIPS yield, bolstered by market expectations of the U.S. Fed raising nominal rates before 2023 on the back of a stronger than expected economic recovery," the analysts said.
Although some analysts see further near-term risk for gold, they warn that the selloff in the bond market is overdone.
In a recent interview with Kitco News, George Milling-Stanley, chief gold strategist at State Street Global Advisors, said that in an environment where the Federal Reserve is expected to keep interest rates at the zero-bound range for the foreseeable future, bond yields at 2% are "irrational."