Gold Asks: Are US Bonds Overvalued? / Commodities / Gold and Silver 2018

“We are in a bond market bubble that’s beginning tounwind.” This is the statement of Alan Greenspan. Is heright? We invite you to read our today’s article about the US bond market andfind out whether it is in bubble or not – and what does it all mean for theprecious metals market. 

Bond yields are inan upward trend since 2016/2017. And they hit the accelerator again last month.The 10-year Treasury yield topped 3.2 percent, the highest level since May2011. Other yields have also increased recently: on 30-year Treasuries hit 3.40in October, while on 5-year US government bonds jumped above 3 percent, as onecan see in the chart below.

Chart 1. Daily yields (in %) on US Treasuries:30-Year (red line), 10-year (orange line), 5-year (green line), 2-year (velvetline), 1-year (blue line) from January 2009 to October 2018.

 
For some analysts, such high levels are notsustainable. However, when you adopt a broader perspective, you will see thatthe bond yields are not extremely high. As the chart below shows, their current levels are still historicallylow. The bond yields used to be much higher in the past – and not only inthe 1970s, when inflation raisedits ugly head, but even in the early years after the Great Recession. 

Chart 2. Monthly yields (in %) on US Treasuries:30-Year (red line), 10-year (orange line), 5-year (green line), 2-year (velvetline), 1-year (blue line) from April 1953 to September 2018.

Actually, many analysts claim the opposite, arguingthat bonds prices, which move inversely to yields, are too high. For example,Bill Gross, a famous bond investor, believes that the bear market in bondprices has just begun. Similarly, Alan Greenspan, theformer Fed Chair has recently said that “weare in a bond market bubble that’s beginning to unwind”. And, at least this isan impression after reading an excerpt from theupcoming book by Paul Volcker, itseems that he would agree with Greenspan.

What is important here is the reason behind therecent moves. The yields increasedbecause traders caught up with the FOMC projections for the federalfunds rate nextyear. We have beenwarning investors for a long time that the divergencebetween traders’ bets and the Fed’s view would not last forever. About twomonths ago, traders were pricing just slightly more than one hike in 2019, eventhough the Fed forecasted three rate increases. Now, the market sees more than two hikes.

Importantly, the breakout in long-term yields madethe yield curve steepen.The spread between 10-year and 2-year yields climbed above 30 basis points,rebounding to the level before the September slide, as one can see in the chartbelow. It’s quite funny as practically all analysts were forecasting theimminent inversion. We were skeptical about that popular narrative (see, forexample, thisarticle) and itturned out that we were right.

Chart 3: Yield curve (spread between 10-year and2-year Treasury yields, in %) from January to October 2018.

However, what really matters is not who was right,but what we could expect for the bond and gold markets in the future. Will theyields on Treasuries continue its rally, or will we see a correction? And howwill all this affect the precious metals?

Well, as the US central banks tapers its holdingsjust when the Treasury borrows so much, we should expect that yields will increase further. Manypeople worry that the increase in yields will burst the bond bubble. It could support the yellow metal,which is perceived as a substitute safe haven forTreasuries.

The only problem is that we have heard about theimminent sell-off for years. But the 10-year yields have recently spiked above3 percent – and nothing happened. The reason for that is that the increase in yields is likely to occur not in asingle, explosive upward move, but gradually over an extended period of time.Moreover, higher yield should spur renewed demand for bonds (if they generatehigher income, they might look more attractive), moderating the impact of anysell-off.

Thebottom line is that we could see even higher bond yields in the future. TheFed’s tightening of monetary policy combined with widening fiscal deficits shouldexert an upward pressure on rates. However, as the US central bank moves relativelyslowly, the increase in yields is likely to also be gradual. The higher demandfor bonds, in particular from foreign investors (just see what is happening inItaly or in certain emerging markets), should moderate the pressure on bondprices. The gradual rise in yieldsshould not demolish the gold market, but it will not help the yellow metaleither. The problem is that nominal yields have been rising not due toinflation, but because of the increase in real interest rates, as onecan see in the chart below.

Chart 4: US real interest rates (10-year Treasuryindexed by inflation, in %) from January 2014 to October 2018.

This isbad news for gold. We believe that the currentmacroeconomic environment remains negative for the yellow metal (although theoutlook is brighter). The recent rebound is understandable given the extreme bearish sentiment previously. However, the US economy expands nicely with nominalgrowth around 4 percent and inflation contained around 2 percent. With highcorporate earnings and solid cash flow we believe that the stock market willcontinue its bull market and themoderate rise in bond yields should notchange it, at least not immediately.

If you enjoyed the above analysis and would you like to knowmore about the gold ETFs and their impact on gold price, we invite you to readthe April MarketOverview report. If you're interested in the detailed price analysis andprice projections with targets, we invite you to sign up for our Gold & SilverTrading Alerts . If you're not ready to subscribe at this time, we inviteyou to sign up for our goldnewsletter and stay up-to-date with our latest free articles. It's freeand you can unsubscribe anytime.

Arkadiusz Sieron
Sunshine Profits‘ MarketOverview Editor

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