Is the Bond Market Unfairly Punishing Gold?

After a record-setting 2020, the price of gold pulled back 9 percent during the first quarter of 2021. Some of this decline can be attributed to a rebound in the U.S. dollar, which tends to have an inverse relationship with gold. And the dollar’s resurgence can be traced to speculative thinking in the U.S. Treasury bond market. That speculation may be off base.

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For much of the year the bond market has been fretting about the possibility of the U.S. economy overheating, fueled by the federal government’s $1.9 trillion stimulus plan, businesses reopening from coronavirus shutdowns, and huge pent-up consumer demand. That has led to anticipation that the U.S. Federal Reserve might reverse its easy monetary policy sooner than expected by raising short-term interest rates to make sure an economic revival doesn’t send inflation skyrocketing.

As Treasury bond yields have climbed, attracting overseas capital, the U.S. dollar has been rising. Since gold trades in dollars in global markets, a rise in the value of the dollar makes gold more expensive in the largest precious metals markets which are overseas. 

It’s as if the bond market doesn’t want to take the Fed at its word. But Fed Chairman Jerome Powell has been consistent, stating the central bank’s policy-making committee has no plans to raise interest rates for the foreseeable future, as it wants to see the annual inflation rate consistently exceed 2 percent. The Fed’s preferred inflation measure is the price index for personal consumption expenditures (PCE), because it includes a broad range of household spending. As of February, the 12-months measure of PCE inflation was 1.6 percent, and, excluding the volatile food and energy components, was just 1.4 percent.

Minutes of the Federal Reserve’s March policy-making committee meeting stated it will be “some time until substantial further progress” is made on boosting inflation and employment.

If the Fed stays true to its words, that could mean bond yields and the dollar will stop their ascent, clearing the way for a possible rebound in gold prices.

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