Now, Congress and the White House have passed a $1.9 trillion COVID relief bill, which has little to do with COVID and everything to do with spending for favored interests, including teachers, municipal workers, federal workers, and community organizers. It also provides money for programs such as the Kennedy Center, the National Endowment for the Arts, etc.
The market view is that this additional $1.9 trillion of spending, combined with the $6 trillion of deficit spending already approved for fiscal 2020 and fiscal 2021 and another $4 trillion deficit spending package expected later this year, is more than the COVID situation requires and more than the economy can absorb without inflation.
Therefore inflation expectations have risen sharply. And, along with inflation expectations, the yield-to-maturity on the benchmark 10-year U.S. Treasury note has spiked.
The yield on the 10-year has risen from 0.917% on January 4 to 1.316% on February 6 to 1.638% today. Those rate hikes might not sound like much, but it’s an earthquake in the note market.
If you compare the rate hikes to the decline in gold prices, there is a high degree of correlation. As rates go up, gold goes down. It’s that simple.
More deficit spending stokes the flames of inflation expectations, which leads to higher rates and lower gold prices. When those fundamental trends are combined with leverage, algo-trading, and momentum, it’s like throwing gasoline on an open flame.
Gold investors have been getting burned.
What’s flawed in this scenario? The short answer: everything.
Perspective
You can’t argue with the facts – rates are going up, and gold is going down. But, the assumptions behind these trends are flawed. That means the trends will inevitably reverse, probably sharply.
Again, perspective helps.
This is not our first interest rate spike. The 10-year note hit 3.96% on April 2, 2010. It then fell to 2.41% by October 2, 2010. It spiked again to 3.75% on February 8, 2011, before falling sharply to 1.49% on July 24, 2012.
You can’t argue with the facts – rates are going up, and gold is going down. But, the assumptions behind these trends are flawed. That means the trends will inevitably reverse, probably sharply.
Again, perspective helps.
This is not our first interest rate spike. The 10-year note hit 3.96% on April 2, 2010. It then fell to 2.41% by October 2, 2010. It spiked again to 3.75% on February 8, 2011, before falling sharply to 1.49% on July 24, 2012.
It spiked again, hitting 3.22% on November 2, 2018, before plummeting to 0.56% on August 3, 2020, one of the greatest rallies in note prices ever.
There’s a pattern in this time series called “lower highs and lower lows.” The highs were 3.96%, 3.75% and 3.22%. The lows were 2.41%, 1.49%, and 0.56%.
The point is that the note market does back up from time-to-time. And when it does, it cannot hold the prior rate highs and eventually sinks to new rate lows.
If we apply that pattern to the current rise in rates, we should expect that the rate increase will top out well short of 2.5%, and a new low may follow as low as 0.25% or even zero. There’s no guarantee of this; it’s not deterministic. But, it would be consistent with the 10-year trend of lowering rates.
Still, there’s more going on. The economy is not nearly as strong as the headlines and Wall Street cheerleaders would have you believe.
- Source, The Daily Reckoning
