Gold Bounce Suggests Yield Surge May Be Overcooked

Gold futures are inching higher early Wednesday after plunging to their lowest level in a week the previous session. Prices are being supported by a slightly weakly U.S. Dollar but capped by another rise in U.S. Treasury yields.

Expectations of an aggressive series of rate hikes by the U.S. Federal Reserve have pulled benchmark Treasury yields higher and reduced the appeal of non-yielding bullion, which is viewed as a hedge against inflation.

However, the Fed will face a problem with investors if it moves too quickly on its rate hikes. Raising rates too fast may telegraph the Fed sees major problems in corralling inflation and this could actually be bullish for gold if it drives the U.S. Dollar sharply lower.

At 08:14 GMT, February Comex gold futures are trading $1815.00, up $3.40 or +0.19%. On Tuesday, the SPDR Gold Shares ETF (GLD) settled at $169.39, down $0.28 or -0.17%.

Treasury Yields Continue to Rise

The 10-year U.S. Treasury yield jumped to its highest point in two years early Wednesday, hovering around 1.893%. The yield on the 30-year Treasury bond is at 2.209 after climbing 7.7 basis points the previous session. Meanwhile, the 2-year rate – which reflects short-term insurance rate expectations – topped 1% for the first time in two years, is trading at 1.061 early Wednesday.

The movement in Treasury yields indicates that investors are preparing for the possibility of more aggressive tightening by the Federal Reserve.

Last week, Fed Chair Jerome Powell told the U.S. Senate that he expected to see a series of interest rate hikes this year, along with a pullback in other pandemic economic support measures.

Philadelphia Fed President Patrick Harker told CNBC last week that the central bank could raise rates three or four times this year. He noted that inflation is “more persistent than we thought a while ago.”

US Dollar Inching Lower Against Peers

Perhaps providing a little support for gold early Wednesday is the slight weakness in the U.S. Dollar. But the price action isn’t strong enough to determine if this move represents the early stages of an intraday trend.

We could get more information later today at 13:30 GMT with the release of the U.S. Building Permits and Housing Starts reports. They could reveal the early impact of the threat of higher interest rates on the housing market. This could be the source of volatility in the gold market along with the movement in the U.S. equity markets.

Short-Term Outlook

Fed officials have gone into a no-comment ‘blackout” period ahead of the next central bank meeting on January 25-26. So traders are on their own.

Although I firmly believe the Fed is on top of the inflation situation, something tells me that the market doesn’t which may be why we’re seeing the rapid surge in yields. I guess they remember the Fed was wrong about inflation being “transitory” so they are taking no chances.

However, there is always the possibility the Fed will move too quickly, which could send a signal to gold bulls that inflation is getting out of control, or there are problems with the economy.