Employees push a trolley laden with crates of one kilogram gold bars at the YLG Bullion International Co. headquarters in Bangkok, Thailand.
Getty Images/Dario Pignatelli/Bloomberg
The price of the US Dollar, Treasuries and Gold have always been interlinked. US interest rate term structure is a key element to consider when looking at their price action and this is what we’re going to look at here.
Any USDxxx FX pair (spot and forwards) is driven by — and reflects — interest rate differentials which are priced into the future. 2017 began where the second half of 2016 left off, which is with decent optimism regarding the US Dollar. The Fed had hiked 25bps in December after a year of inaction, and the US economy seemed to be motoring along. The Fed Fund futures market was pricing three full hikes in 2017 and a further three in 2018.
But then things started to change: Q1 GDP was revised a lot lower (though seasonality has seen consistently weak Q1 GDP readings), inflation seemed to plateau and the Trump administration started to falter on their pre-election promises. It’s worth noting that employment has remained very strong and although participation rate has steadily fallen to near 40-year lows, the job market remained buoyant. The March rate hike was duly delivered but the change in sentiment moved interest rate expectations: just three further 25bp hikes in the rest of 2017 and 2018 combined. The DXY index completed a false breakout on the monthly chart and looks like it may be heading for Learn Alot more weakness.
US Treasuries naturally are greatly affected by US interest rates (bonds 101: as rates fall price goes up and vice versa). The recent downturn in US rates expectations has kept 10 UST yields within the truly formidable 20-year downward channel. It’s very interesting to note that the recent peak in yield coincided with the December 2016 rate hike; a clear sign that the market believes that the Fed will not be able to sustain its planned hiking path. USTs also happen to be one of the most popular flight-to-quality targets and as a result global uncertainty has given them a steady bid.
Finally, we turn to gold. This is also driven by long-term yields, in fact it’s most correlated to long-term real
yields (nominal yield minus inflation). When real yields drop, gold price tends to rise and vice versa. Unsurprisingly, since the end of 2016 gold has been on a steady and consistent bull run. Its price is also greatly driven by money / credit supply and it’s obviously a popular safe haven asset. Gold has relatively little use beyond its store of value capacity — it is of course used in industry, jewellery etc but the majority of physical gold in existence lies idle in a vault or a safe. So, its value is effectively defined as what someone is prepared to pay for it. It’s a controversial asset but one which has withstood the test of time, being used as currency for thousand of years.
So, to summarize all the above, the Dollar — Treasuries — Gold trinity is greatly affected by the term structure of US interest rates. If someone trades one of the three instruments it’s always useful to monitor the other two, as they can provide telltale signs for market direction. Very often and depending on general market circumstances, one of these instruments leads the other two.