Fed Cuts Rates – Bonds Making Less Sense
Last night, as widely expected, the US Fed drop rates again by 0.25%. Whilst the last cut was described as just an ‘insurance’ cut (just in case) this seemingly makes this cut ‘a little more insurance’ not a normal rate cut, just as the current liquidity injection money printing program is ‘not QE’…
Whilst market reaction was subdued as it was so widely expected and priced in, initially gold did drop on confirmation the target rate had been lowered 0.25% to just 1.5-1.75%. However the chairman, Powell, later went on to say “I think we would need to see a really significant move up in inflation that’s persistent before we even consider raising rates to address inflation concerns.” That single statement then saw gold surge back up to just under $1500 in the session and the USD fall. Clearly we’re more likely to see more drops than rises…
Given the Fed’s exemplary record of being behind the curve the market could easily glean that despite Powell’s assertions that the “current stance of policy is likely to remain appropriate” that they continually overestimate everything being more awesome than it is.
Topically, all of this happened after a surprise beat of the expected 1.6% US Q3 GDP print at 1.93%. However despite Trump tweeting “The Greatest Economy in American History!” just moments before, looking behind the headline figure showed that personal consumption, at 1.93%, was in effect 100% of the 1.93% GDP print. In other words, all other GDP components netted to 0%.... There have been plenty of articles lately outlining how this personal consumption has been, you guessed it, debt fuelled and increasingly of a poor quality of debt (subprime redux).
So as rates are dropped again and bond yields drop again, the question being asked more and more is why would you hold bonds rather than gold for your safe haven asset? Traditionally, Wall St types prefer bonds as they have ‘full faith’ and the bonds pay a yield. More and more investors are starting to look at the risk v return of that proposition. Why take on a fiat based debt instrument with the accompanying counterparty risk and a millennia strewn with defaults and when the yield is so low? You can own gold with absolutely no counterparty risk at all. Let’s remember too that there are around $13 trillion in negative yielding bonds where you are in effect paying to hold that risk!
As the World Gold Council noted yesterday in an investment note about this rotation out of bonds into gold:
“One of the key drivers of gold, especially in the short and medium term, is the opportunity cost of holding it. Unlike bonds, gold does not pay interest or dividends because it does not have credit risk. This lack of yield can deter investors. But in an environment where 26% of developed market sovereign debt is trading with negative nominal rates and, once adjusted for inflation, a whopping 82% trades with negative real rates, the opportunity cost of gold almost goes away, even providing what can be seen as a positive “cost of carry” relative to sovereign bonds.
Gold prices have responded to the surge in negative real-yielding debt, as evidenced by the strong positive correlation between the amount of debt and price of gold over the past four years. To some degree, this illustrates the erosion of confidence in fiat currencies related to monetary intervention.”