Weaker USD Shields Gold From Surging Yields

Gold has been swinging either side of the $1790 level in recent trade in wake of the latest jobs report. XAU/USD is being shielded from higher yields by the weaker US dollar, and if this reverses, gold will be in trouble.

Gold is nervously holding on to very modest on-the-day gains of about 0.2%, with prices swinging either side of the $1790 level as traders digest the implications of the latest US labour market report. Trading conditions after the mixed report, which reflects headline jobs growth does disappoint but also reflects improvements in measures of slack and strong wage growth, have been variable and two-way.

XAU/USD hit lows around $1782 and high around $1796 and is currently trading towards the upper end of this intra-day range around $1794.

Gold has been surprisingly resilient in wake of the report which analysts interpreted as endorsing the Fed’s tightening plans for 2022. Earlier in the week, the FOMC minutes laid out the stance, so long as labour market progression continues at the current pace. Interest rate hikes would soon be warranted.

The jobs report appears not to have boosted the market’s expectations for further near-term rate hikes (hence US 2-year yields remaining flat around 0.87%), it seems to have boosted the market’s conviction in the Fed’s long-term rate trajectory.

10-year yields recently broke above the 2021 high at 1.77% and came within a whisker of hitting 1.80%. At current levels of around 1.78%, they are around 5bps higher on the day.

Half of this move came from a small boost to inflation expectations, but half is coming from a boost to underlying real yields, with the 10-year TIPS hitting fresh multi-month highs above -0.75% in recent trade.

Usually, when real and nominal yields rise, this increase in the opportunity cost of holding non-yielding assets weighs on the demand for precious metals. However, US dollar-denominated gold prices are being held up by weakness in the dollar.

In a surprise for investors and traders, the dollar has been weakening in recent trade despite the positive reaction seen in US bond yields to the latest jobs report. Positioning could be overstretched, and the dollar could be struggling amid profit-taking.

Either way, the weaker dollar is making the price of USD-denominated gold more affordable for international investors, thus negating the negative impact of higher real yields.

Many market observers have been calling for the dollar to move higher given the recent surge in long-term US bond yields this week as conviction in the Fed’s ability to get rates back to pre-pandemic levels grows. On the week, 10-year nominal yields are up over 25bps, whilst 10-year real yields are up more than 35.

The dollar may now be seen by some as cheap given the recent widening in US/G10 rate differentials in favour of the American currency. The bigger relative moves higher in real yields represent a drop in inflation expectations, lessening the appeal for inflation protection, a key reason why investors buy gold.

If current trends in bond markets continue and the dollar starts to pick up, XAU/USD may well be headed back to 2021 lows under $1700 in the next few months.