A government shutdown + declining consumer confidence

Key Points

  • The US government shut down most operations on Wednesday as Congress failed to reach a deal to raise the debt ceiling.
  • Government shutdowns do not usually have a lasting effect on financial markets, but the fiercely divided House threatens a bitter standoff.
  • Declining consumer confidence and further signs of a weakening labor market will likely contribute to a slowing economy.

The Conference Board’s measure of consumer confidence declined to 94.2, remaining at 2020 pandemic levels since a steep plunge in April 2025.

Conference Board: Consumer Confidence

Labor Market

Signs of a weakening jobs market are growing, with unemployment rising above job openings in August, for the first time since April 2021.

Job Openings

Temporary employment declined to 2.5 million. Low temporary hires indicate declining employer confidence in the economic outlook.

Temporary Employment

Declining average weekly hours worked warn of increased layoffs in the months ahead.

Average Weekly Hours

A low quit rate of 1.9% reflects declining employee confidence in the job market.

Quit Rate

Stocks

The S&P 500 continues to test resistance at 6700 despite concerns over the government shutdown. A breakout would offer a medium-term target of 6900.

S&P 500

Financial Markets

High-yield spreads remain at a low 7.5%, indicating credit is readily available in financial markets.

Junk Bond Spreads

Bitcoin is more tentative, having twice tested support at 110K. A breach of the support level would warn of a sharp contraction in financial market liquidity.

Bitcoin (BTC)

Treasury Markets

10-year Treasury yields will likely retest resistance at 4.2% in the next few days, driven by uncertainty from the government shutdown. A breakout above 4.2% would offer a medium-term target of 4.4%.

10-Year Treasury Yield

Dollar & Gold

The US Dollar Index retreated below support at 98, but the outlook for lower interest rates remains uncertain.

Dollar Index

Gold climbed to $3,868 per ounce, demand fueled by the increased uncertainty. A breakout above $3,900 would signal a test of our year-end target of $4,000.

Spot Gold

Silver ripped through our target of $45 per ounce, with rising Trend Index troughs signaling strong buying pressure. A breakout above resistance at $47 would offer a target of $50.

Spot Silver

Platinum has re-joined the party, with a breakout above $1,500 offering a target of $1,700.

Platinum

Conclusion

Uncertainty over the US government shutdown has boosted demand for precious metals. Resolving partisan differences over government funding and extending healthcare benefits will likely prove difficult.

Consumer confidence is low, and a weakening labor market warns of a slowing economy. An extended shutdown would further undermine spending, pushing the economy closer to a recession.

Strong financial market liquidity supports high stock prices, but a Bitcoin retreat below 110K would warn of a contraction that would hurt equity markets.

Acknowledgments

Bond yields and the dollar fall as gold reaches a new high

Key Points

  • Long-term Treasury yields are falling steeply in anticipation of more Fed rate cuts as the economy slows.
  • The S&P 500 is retracing to test short-term support at 6500.
  • Financial market liquidity remains strong, supporting stocks.
  • The dollar is weakening, and gold and silver soared to new highs.

10-year Treasury yields fell to 4.046% testing the long-term band of support between 4.0% and 4.1%.

10-Year Treasury Yield

Expectations of steeper Fed rate cuts grow as more evidence emerges of a slowing economy. The Cass Freight Index is in a strong downtrend, and a fall below 1.0 would signal a recession. A useful barometer of economic activity, the index measures the number and cost of freight shipments across North America based on data from hundreds of large shippers.

Cass Freight Index

The current turmoil over tariffs — after the US Appeals court overruled Donald Trump’s “reciprocal” tariffs and his earlier “fentanyl” tariffs against China, Canada, and Mexico — will likely cause a sharp contraction in capital investment due to the uncertainty, almost guaranteeing a recession. Trump has lodged an appeal with the Supreme Court, but a decision is unlikely before next year. Unless he can get a stay on the lower court’s ruling, Treasury will be forced to fund the billions of dollars in tariffs collected.

While some believe that overturning the tariffs would cause a blowout in the fiscal deficit, we believe that the promise of a boost in revenue from tariffs was more spin than substance. There are no free lunches in economics; when something looks too good to be true, it usually is. Most of the cost of tariffs is currently borne by US corporations, but will likely be pushed onto consumers through price increases over the next year.

Goldman Sachs: Estimated Incidence of Tariff Costs

Where corporations do not pass on tariffs to customers, their profits and corporate tax paid to the Treasury will decline. Falling profits also hurt stock prices, reducing capital gains taxes. US consumers and corporations will directly or indirectly pay for the tariffs, and the impact on net Treasury receipts will likely be marginal.

Our biggest concern is not the loss of tax revenues, but the economic impact of policy uncertainty.

Stocks

The S&P 500 is retracing to test its latest support level at 6500, but rising Trend Index troughs indicate buying pressure, and respect of support will likely signal a further advance.

S&P 500

The equal-weighted S&P 500 ($IQX), more representative of large caps than the headline index, tests similar support at 7600. Rising Trend Index troughs again indicate buying support and likely continuation of the uptrend.

S&P 500 Equal-Weighted Index

Financial Markets

High-yield bond spreads are declining, indicating the return of loose financial conditions supporting high stock prices.

Junk Bond Spreads

Bitcoin (BTC) respected support at 110K, further indicating easing financial conditions — a bullish sign for stocks.

Bitcoin (BTC)

Dollar & Gold

The dollar is weakening in line with the outlook for interest rates. A US Dollar index breach of the long-term band of support between 96.5 and 97 would strengthen our long-term target of 90.

Dollar Index

Gold closed at a new high of $3,645 per ounce, while rising Trend Index troughs signal buying pressure. Expect a retracement to test support between $3,500 and $3,600, but respect will likely confirm an advance to $4,000 by the end of the year, as the dollar weakens.

Spot Gold

Silver is testing resistance at $41.50 per ounce. Again, we expect a retracement followed by a further advance, with a target of $44.

Spot Silver

Energy

Brent crude held steady at close to $66 per barrel after the OPEC+ meeting on the weekend decided on a smaller-than-expected initial increase in production of 137,000 barrels per day, in a phased unwinding of the 1.66 million barrels per day post-COVID production cut.

Brent Crude

Conclusion

Cyclical pressures are driving long-term yields lower, with a slowing economy likely to cause steeper-than-expected Fed rate cuts. Added uncertainty over tariffs increases the risk of a recession.

Loose financial conditions, boosted by falling Treasury yields, support stock prices, but a slowing economy would be bearish for earnings.

The dollar is weakening in response to the expected fall in interest rates, and a US Dollar Index breach of support between 96.5 and 97 would strengthen our long-term target of 90.

We expect gold and silver to rise as the dollar weakens, with respective targets of $4,000 and $44 per ounce by the end of the year.

 

Acknowledgments

Weak labor report hammers stocks

Key Points

  • The S&P 500 and Dow fell sharply on the poor July jobs report
  • Financial markets warn of easy credit conditions, which could lead to markets mispricing risk
  • Real GDP growth is misleading due to the buildup of inventories in Q1, ahead of tariffs, and their subsequent rundown in Q2
  • Long-term Treasury yields fell, and the dollar weakened, anticipating lower interest rates
  • The fall boosted demand for gold

July payrolls increased by 73K, below the estimate of 104K, but big downward revisions to the previous two months spooked investors. A combined revision of -258K to May and June employment lowered job gains to 19K and 14K, respectively.

Employment Growth

Stocks were hammered, with the S&P 500 displaying a bearish engulfing on the weekly chart. Breach of support at 6200 would signal a correction to test 6000.

S&P 500

The Dow Jones Industrial Average failed to confirm the S&P 500 bull market signal and has now broken support at 44K, warning of a correction to 42 K.

Dow Jones Industrial Average

Financial Markets

The Chicago Fed National Financial Conditions Index warns of further easing with a fall to -0.57, signaling loose monetary conditions similar to 2021 during the COVID pandemic.

Chicago Fed National Financial Conditions Index

During the week, we highlighted the risk of a credit bubble if super-easy financial conditions persist:

Looser monetary policy would accelerate credit growth (light blue) above the nominal GDP rate (dark blue), leading to malinvestment as in the credit bubble preceding the 2008 global financial crisis. Mispricing risk feeds instability, leading to an inevitable collapse when assets reprice.

Bank Credit & Nominal GDP Growth

Bond market guru Jim Grant today confirmed the worrying speculative bonanza:

It’s a speculative-credit bonanza. Freewheeling conditions in the primary market pushed leveraged loan activity to new heights in July, with domestic new issuance reaching $223.2 billion. That’s the largest one-month total on record, comfortably topping the prior $206 billion peak established in January….

“I haven’t seen a market quite like this post the Great Financial Crisis,” Jon Poglitsch, managing director at Sycamore Tree Capital Partners, marveled to Bloomberg Wednesday. There’s a “grab for spread where anyone can find it,” he noted.

Loose financial conditions will likely be exacerbated if the Fed caves to political pressure and cuts interest rates, risking a credit bubble.

Treasury Markets

The weak jobs report swept aside concerns over the uptick in June core PCE inflation to 2.8%.

PCE & Core PCE

10-year Treasury yields plunged, anticipating Fed rate cuts, testing long-term support at 4.2%.

10-Year Treasury Yield

Economy

Real GDP growth recovered to an annualized rate of 2.9% in Q2, but the numbers are misleading. The biggest contributor was a sharp reduction in inventories after massive Q1 pre-orders, front-running the tariffs announced by President Trump in April. The contraction in Q2 aggregate hours worked reveals a far gloomier picture.

Real GDP & Total Hours Worked

A 50K July decline in employment in cyclical sectors — manufacturing, construction, transportation, and warehousing — warns that the economy is slowing.

Cyclical Employment

Labor Market

Job openings and unemployment remain in balance, as highlighted by Chair Powell at this week’s FOMC announcement.

Job Openings

Annual growth in average hourly earnings at 3.9% reflects reasonable labor demand.

Average Hourly Earnings

Dollar & Gold

The US Dollar Index fell sharply on the July jobs report, anticipating lower interest rates ahead.

Dollar Index

The fall boosted demand for gold, which is testing resistance at $3,360 per ounce. Breakout would signal a test of $3,440.

Spot Gold

Conclusion

A weak jobs report, with falling employment in cyclical sectors, warns that the economy is slowing. Stocks are expected to undergo a correction, with the S&P 500 testing support at 6000 and the Dow testing 42K.

Interest rates are expected to fall, with the Fed cutting rates to create a soft landing. Lower interest rate expectations have also weakened the dollar and boosted demand for gold.

Easy credit conditions increase the risk of a credit bubble, which could lead to investors mispricing risk.

We are underweight stocks except for defensive sectors, and overweight cash, gold, and short-term financial assets.

Acknowledgments

S&P 500 weakens and gold rallies

Key Points

  • The S&P 500 closed above 6300 for the first time, supported by strong liquidity
  • But declining Trend Index peaks warn of a retracement
  • Consumer Confidence remains weak, and the Conference Board Leading Economic Index signals a recession
  • Gold and silver rallied as the dollar weakened

The S&P 500 closed above 6300 for the first time, but declining Trend Index peaks warn of selling pressure. Expect retracement to test support at 6100.

S&P 500

The Dow Jones Industrial Average also signals weakness, with declining Trend Index peaks indicating selling pressure.

Dow Jones Industrial Average

The Broad DJ US Index (red) has underperformed the DJ World ex-US index (blue) over the past six months.

DJ US Index ($DJUS) & DJ World ex-US ($W2DOW)

Financial Markets

Financial markets grow increasingly supportive, with the Chicago Fed National Financial Conditions Index (NFCI) declining to -0.54. Values above zero are considered restrictive.

Chicago Fed National Financial Conditions Index

Bitcoin has retraced slightly from resistance at $120K, but still signals bullish market conditions.

Bitcoin (BTC)

Treasury Markets

10-Year Treasury yields declined to 4.35%, but rising Trend Index troughs signal continued buying pressure.

10-Year Treasury Yield

Economy

Consumer confidence remains low, with the Conference Board index declining by 5 points to 93, similar to levels during the 2020 pandemic.

June’s retreat in confidence was shared by all age groups and almost all income groups. It was also shared across all political affiliations, with the largest decline among Republicans.

Conference Board: Consumer Confidence

The Conference Board’s Leading Economic Index (LEI) declined to 99.8% in June. Six-month growth in the LEI (blue) fell to an annualized -5.6%, below the -4.1% that signals a recession (marked in red).

Conference Board Leading Economic Index - Recession Signals

The black line on the above chart indicates negative growth in more than 50% of the LEI components below over the past six months. A broad decline confirms the recession signal.

Conference Board Leading Economic Index - Components

Dollar & Gold

The Dollar Index retreated below support at 98, signaling another decline. A breach of support of 96.50 would strengthen our long-term target of 90.

Dollar Index

Gold rallied to test resistance at $3,400 per ounce. A breakout above $3,400 would offer an immediate target of $3,500 and strengthen our year-end target of $4,000.

Spot Gold

Silver is testing resistance at $39 per ounce. A breakout would offer a target of $42, but declining Trend Index peaks warn of stubborn resistance.

Spot Silver

Conclusion

The S&P 500 closed at a new high, but declining Trend Index peaks warn of selling pressure.

The Dow Industrial Average respected resistance at 45,000, failing to confirm the S&P 500 bull market signal.

Financial market conditions indicate strong liquidity, but consumer confidence is weak, and the Conference Board Leading Economic Index signals a recession.

The US Dollar Index retreated below support at 98, triggering a rally in gold and silver. A gold breakout above $3,400 would offer an immediate target of $3,500 and strengthen our year-end target of $4,000. A silver breakout above $39 would offer a target of $42, but declining Trend Index peaks warn of stubborn resistance.

Acknowledgments

Long bonds fall as CPI rises, stocks and gold remain bullish

Summary

  • Global long bond yields are rising, driven by fears over government debt levels
  • A sharp jump in services CPI warns of rising inflation in the broad economy
  • Strong liquidity boosts demand for stocks and for gold

Global long bond yields are rising, driven by fears over government debt levels.

Japan’s 30-year JGB yield jumped to a record 3.20% on Tuesday as opposition parties favoring tax cuts and loose monetary policy are expected to gain influence after the July 20 election. (Reuters)

German 30-year government bond yield is testing resistance at 3.26%, the highest since 2011. Investor concerns are focused on increased debt issuance—to fund defense and infrastructure spending—and rising international rates. (Reuters)

The 30-year US Treasury yield is testing resistance at 5.0%, the highest since 2007. The monthly charts below provide a long-term perspective.

30-Year Treasury Yield

10-year Treasury yields are expected to follow, testing resistance at 5.0%.

10-Year Treasury Yield

Rising yields are driven more by long-term structural issues than immediate concerns over an uptick in inflation.

CPI Inflation

CPI growth jumped to 2.7% for the twelve months to June, while core CPI, excluding food and energy, increased by 2.9%.

CPI & Core CPI - Annual

Sticky price CPI and the 16% trimmed mean, reflecting underlying inflationary pressures, jumped to 2.5% and 3.2% respectively.

Sticky CPI

More surprising was the sharp rise in CPI for services, excluding shelter, which is less affected by tariff increases than goods. The June figure is close to a 7.0% annual growth rate.

CPI Services excluding Shelter Rents

This confirms the earlier ISM Services PMI, which showed a sharp rise in the Prices sub-index in May and June. According to the ISM, fourteen of eighteen service industries reported increased prices paid in June. (ISM)

ISM Services Prices

Energy

Energy CPI showed negative growth for the twelve months to June, contributing significantly to the overall low headline CPI rate.

CPI & CPI Energy - Annual

Shelter

Shelter CPI comprises 35% of headline CPI. However, compared to the Case-Shiller 20-City Composite Home Price Index below, we find the index highly artificial and misleading.

CPI Shelter

Food

Food CPI growth increased in June to an annualized rate of 3.8%.

CPI Food

Stocks

The S&P 500 eased slightly in response to the CPI increase, but this is hardly noticeable on the monthly chart below.

S&P 500

The Dow Jones Industrial Average retreated from resistance at 45K. However,  rising Trend Index troughs signal long-term buying pressure, and a breakout above 45K would confirm the S&P 500 bull market signal.

Dow Jones Industrial Average

Financial Markets

Moody’s Baa Corporate bond spread declined to 1.73% after a sharp spike in March-April, indicating ready credit availability.

Moody's Baa Corporate Bond Spreads

The uptrend in Bitcoin indicates strong animal spirits, which are likely to spill over to stocks.

Bitcoin (BTC)

Dollar & Gold

The US Dollar Index is retracing to test resistance at 100 on the monthly chart below. Respect will likely confirm another decline, and our target of 90.

Dollar Index

Gold is consolidating in a bullish pennant on the monthly chart. Rising Trend Index troughs also signal buying pressure. A breakout above 3450 would strengthen our target of 4000 by year-end.

Spot Gold

Conclusion

Long bond yields are rising due to concerns over precarious public debt levels and growing fiscal deficits.

Inflation is still a secondary consideration, but a sharp rise in the CPI for services in June warns of higher inflation in the broader economy. Services are less impacted by tariffs, which are only likely to affect CPI after current pauses have expired and tariff rates are settled.

Liquidity remains strong, supporting high stock prices. A Dow Jones Industrial Average breakout above 45K would confirm the S&P 500 bull market signal.

Demand for gold is also strong, and a breakout above $3,450 per ounce would signal another advance, strengthening our target of $4,000 by year-end.

Acknowledgments

Gold, the Dollar and a big hole in the desert

Summary

  • Stocks rallied on news of a ceasefire between Iran and Israel
  • But celebrations may be premature
  • The dollar weakened, which is likely to boost demand for gold

The S&P 500 rallied to test resistance at 6100. Breakout would signal a fresh advance, but declining Trend Index peaks warn of selling pressure.

S&P 500

Uncertainty remains high.

The White House was quick to claim victory after the US airstrike on Iranian nuclear enrichment facilities. But claims that the subsequent ceasefire is the start of a new era of peace in the Middle East will likely prove premature.

A ceasefire is not a peace settlement. It’s a pause in hostilities that allows both parties to rearm and re-strategize.

A precision strike is nothing more than a big hole in the desert, the effectiveness of which can only be determined by subsequent Iranian actions.

The damage assessment reported by CNN is premature, but it does raise some interesting questions.

The assessment, which has not been previously reported, was produced by the Defense Intelligence Agency, the Pentagon’s intelligence arm. It is based on a battle damage assessment conducted by US Central Command in the aftermath of the US strikes, one of the sources said.

The analysis of the damage to the sites and the impact of the strikes on Iran’s nuclear ambitions is ongoing, and could change as more intelligence becomes available.

….Two of the people familiar with the assessment said Iran’s stockpile of enriched uranium was not destroyed. One of the people said the centrifuges are largely “intact.” Another source said that the intelligence assessed enriched uranium was moved out of the sites prior to the US strikes. (CNN)

If the stockpile of enriched uranium were moved or otherwise not destroyed, how would this affect Israel’s security?

The only way to finish this is with boots on the ground. Neither Israel nor President Trump is likely to commit to that.

In the Treasury market, 10-year yields declined to 4.3%, easing the pressure on stocks.

10-Year Treasury Yield

However, the dollar continues to weaken, with the US Dollar Index testing support at 98. A breach would confirm our target of 90.

Dollar Index

The chart below shows how Brent crude and the dollar moved contra-cyclically, with the dollar weakening when crude oil prices rose, and vice versa.

However, that changed shortly before Russia’s full-scale invasion of Ukraine in 2022, the dollar strengthened despite a spike in energy prices, diverging from past behavior as investors sought safety. The divergence continues, with the dollar weakening while crude oil prices are falling. The dollar’s role is under threat.

Brent Crude & USD Index for Advanced Economies

Investors globally appear to be gradually reducing their exposure to dollar-denominated assets, driving the greenback down to its lowest level against a basket of major currencies in three and a half years….

According to Bank of America’s FX strategy team, European “real money” investors – institutions like pension funds and insurance companies – are the main drivers of the dollar’s selloff in the second quarter, slashing their dollar positioning to the lowest since 2022 in a matter of weeks.

But the story might not be so straightforward…. research shows that most of the dollar’s average daily declines in the last few months have come in Asian trading hours, suggesting Asian holders of U.S. bonds may also be increasing their dollar hedges. (Reuters)

Demand for gold remains strong as the dollar weakens, with the metal finding support at $3,300 per ounce. Respect of this level would signal another test of resistance at $3,400.

Spot Gold

Conclusion

Stocks have rallied, but uncertainty in the Middle East remains high.

Long-term Treasury yields have softened, but the dollar continues to weaken, reflecting uncertainty over the US role in the global monetary system.

Private investors have replaced central banks as major investors in US Treasuries. They are far more price sensitive, and both European and Asian investors are increasingly hedging their dollar positions, expecting dollar weakness.

A weakening dollar is expected to boost demand for gold.

Acknowledgments

Gold rallies as the dollar weakens

Summary

  • The S&P 500 is consolidating below 6000, and financial market liquidity is improving
  • However, US stocks are underperforming their global counterparts
  • Gold rallies as LT Treasury yields rise and the dollar weakens

The S&P 500 is consolidating between 5800, its former primary support level, and 6000 on the weekly chart below. Breakout to a new high would signal a return to bull market conditions, but we expect strong resistance between 6000 and 6100.

S&P 500

The Dow Jones Industrial Average has similarly recovered above former primary support at 42K, but does not yet signal a reversal to a primary uptrend.

Dow Jones Industrial Average

US stocks continue to underperform their global counterparts, with the broad DJ US Index (DJUS) lagging the Dow Global ex-US ($W2DOW).

DJ US Index ($DJUS) & DJ World ex-US ($W2DOW)

Financial Markets

Bitcoin reached a new high at 107K, signaling strong risk appetite in financial markets.

Bitcoin (BTC)

A sharp fall in high-yield (junk) corporate bond yields signals improving credit availability in financial markets.

Junk Bond Spreads

Treasury Markets

10-Year Treasury yields are retracing to test new support at 4.5%. Respect will likely confirm our target of 5.0%.

10-Year Treasury Yield

Economy

The Conference Board’s leading economic index plunged sharply to 99.4% in April, the 1.0% drop following a 0.8% fall in March. The LEI is blue on the chart below.

Conference Board Leading Economic Index

Widespread weakness across the LEI’s ten components warns of a broad slowing of the economy.

Conference Board Leading Economic Index - Components

The LEI below 100 warns of a recession ahead (black line below), but six-month growth in the LEI (blue below) has not quite reached -4.1%, which would trigger a recession signal (red).

Conference Board Leading Economic Index - Recession Signals

Dollar & Gold

The Dollar Index is retracing to test the band of support between 98 and 100. Breach of support would signal long-term dollar weakness, offering a target of 90.

Dollar Index

Gold found support at 3200 and, after breaking above 3250, is headed for a test of resistance between 3400 and 3500. Our long-term target is 4000 by the end of 2025.

Spot Gold

Silver is testing resistance at 34. Breakout would offer a target of 39.

Spot Silver

Conclusion

The S&P 500 is rallying as financial market liquidity improves, but we expect strong resistance between 6000 and 6100. US stocks continue to underperform their global counterparts, while the Conference Board’s leading economic index warns that the US economy is headed for recession.

10-year Treasury yields are rising, and respect of support at 4.5% would offer a target of 5.0%, another bear signal for stocks. The dollar is weakening, reflecting international capital outflows from US financial markets. A breakout of the Dollar Index below long-term support at 100 would warn of another decline, with a target of 90.

Gold is rising as the dollar weakens, and we expect another test of resistance between 3400 and 3500. Breakout would signal a fresh advance towards our long-term target of 4000 by the end of 2025.

Acknowledgments

Fed sits tight as economic outlook darkens

The Fed has kept the funds rate steady at 4.25% to 4.5% since December. The threat of a trade war and the increased risk of a sharp price jump have ensured Fed caution over further rate cuts. The FOMC dot plot below shows four participants expect no cuts this year, another four expect one cut of 25 basis points, and eight more expect a total of 50 basis points.

FOMC Dot Plot

FOMC projections identify rising uncertainty over GDP growth and greater risk of an undershoot.

FOMC: GDP Risk

Consumer expectations of inflation soared in the March University of Michigan survey, with the median price increase in the next year jumping to 4.9%.

University of Michigan: 1-Year Inflation Expectations

Expectations of future conditions fell sharply to 54.2.

University of Michigan: Consumer Expectations

Stocks were buoyed by Fed Chair Jerome Powell’s view that tariff-driven inflation will be “transitory” and largely confined to this year. (Reuters)

The Dow Industrial Average rallied to test resistance at the former primary support level of 42,000.

Dow Jones Industrial Average

The S&P 500 recovered some ground but encountered resistance at 5700, below the former primary support level.

S&P 500

Long-term Treasury yields benefited from the outflow from equity markets in February and March, with the 10-year testing support at 4.1% before increasing to 4.25%. A further fall in stocks would likely cause a short-term softening of UST yields.

10-Year Treasury Yield

Upward pressure on US Treasury yields will likely come from doubts over the current administration’s economic strategy and concerns over a debt-ceiling stoush. US credit default swap spreads (CDS) have increased by 200% since December.

United States Treasury: 1-Year Credit Default Swaps

A sharp upturn in the Chicago Fed National Financial Conditions Index warns of tightening financial conditions, with credit spreads widening.

Chicago Fed National Financial Conditions Index

The Fed confirmed they will reduce the monthly redemption cap on Treasury securities from $25 billion to $5 billion. This will slow the withdrawal of liquidity from the Treasury market through the QT program.

Conclusion

The Treasury market has shown that it is still vulnerable to thin demand and requires Fed support to maintain liquidity in the long-term end of the curve. The Fed has been forced to cut monthly QT for Treasury securities to $5 billion. At the new rate, it would take the Fed more than 70 years to shed its present holdings of $4.24 trillion.

Fed Security Holdings

Stocks are rallying but are unlikely to reverse the recent bear market signal.

Acknowledgments

The long game: The Dollar, Gold and US Treasuries

In the short term, the Fed and US Treasury manipulate the Dollar and US Treasury yields in an attempt to stimulate the economy while avoiding inflation. Foreign central banks also attempt to manipulate the Dollar to gain a trade advantage, which impacts the Treasury market. However, in the long term, large secular trends lasting several decades will likely determine the direction of US financial markets and fuel a bull market for gold.

Short-term Outlook

Inflation has moderated, with CPI falling below 3.0%, allowing the Fed to cut interest rates. The fall in headline CPI (red, right-hand scale) was precipitated by a sharp decline in energy prices (orange, left-hand scale).

CPI & Energy CPI

However, inflation could rebound if geopolitical tensions restrict supply or demand grows due to an economic recovery in China and Europe or further expansion in the US.

The Fed has cut its interest rate target by 1.0% from its 2024 peak to stimulate economic activity.

Fed Funds Target Rate: Mid-point

Efforts to normalize monetary policy have reduced Fed holdings of Treasury and mortgage-backed securities by $2 trillion. This would typically contract liquidity, stressing financial markets.

Fed Holdings of Treasuries & Mortgage-backed Securities (MBS)

However, the Fed neutralized its QT operations by reducing overnight reverse repo (RRP) liabilities by nearly $2.3 trillion. Money market funds were encouraged to invest in the enormous flood of T-bills issued by Janet Yellen at the US Treasury instead of in reverse repo from the Fed. The simultaneous reduction in UST assets and RRP liabilities on the Fed’s balance sheet left financial market liquidity unscathed.

Fed Reverse Repo Operations

Long-term Treasury yields climbed despite the Fed reducing short-term rates, indicating bond market fears of an inflation rebound. However, a benign December reading for services CPI (below) triggered a retracement.

CPI & Services CPI

Respect of support at 4.5% will likely signal an advance to test resistance at 5.0% on the 10-year Treasury yield below.

10-Year Treasury Yield

The Dollar Index found support at 109 and is expected to re-test resistance at 110. The strong Dollar increases pressure on foreign central banks to sell off reserves to defend their currencies, driving up yields as foreign selling of Treasuries grows.

Dollar Index

Gold is trending upwards despite rising Treasury yields and the strong Dollar. Breakout above $2,800 per ounce would offer a medium-term target of $3,000.

Spot Gold

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The Long Game

The elephant in the room is US federal debt, which had grown to $35.5 trillion at the end of Q3 in 2024.

Federal Debt

Fiscal deficits are widening, with interest servicing costs recently overtaking defense spending in the budget.

CBO Projected Federal Deficit

Federal debt (red below) is growing faster than GDP (blue), warning that the fiscal position is unsustainable, especially as interest servicing costs widen the gap.

Federal Debt & GDP Growth

The ratio of federal debt to GDP grew to a precarious 113.3 percent at the end of Q3 2024 and is expected to accelerate higher.

Federal Debt to GDP Ratio

Long-term Treasury yields are rising as concerns grow over the unsustainability of debt and deep fiscal deficits fueling long-term inflation.

10-Year Treasury Yield

The strong Dollar further exacerbates the situation, increasing sales of US Treasuries, as mentioned earlier, when foreign central banks free up reserves to protect their currencies. The incoming Republican administration has committed to preserving the Dollar’s status as the global reserve currency. Maintaining reserve currency status is likely to entrench a strong Dollar. A Dollar index breakout above 110 will offer a target of the high at 120 from 2000, as shown on the quarterly chart below.

Dollar Index

As Luke Gromen points out, the Fed can cut interest rates to weaken the Dollar, but that would increase fears of inflation and, in turn, drive up Treasury yields. So, the rise in long-term Treasury yields is almost inevitable.

Gold respected support at $2,600 per ounce, as shown on the monthly chart below. The secular uptrend is fueled by four key concerns. First is the sustainability of US federal debt. Next is fear of rising inflation exacerbated by the on-shoring of critical supply chains and a decline in international trade. Third are geopolitical tensions, fostering rising demand for the safety of gold and an increased desire by non-aligned nations to break free from Dollar hegemony. Last is the collapsing Chinese real estate market, which no longer serves as the primary investment for private savings, leaving gold the most attractive alternative.

Spot Gold

Breakout above $2,800 would offer a long-term target of $3,600 per ounce.

Conclusion

Treasury yields are in a secular uptrend, with the bond bear market expected to last at least a decade. The primary driver is concern over the sustainability of US federal debt, which exceeds 110% of GDP, while deficits threaten to expand. Not far behind are fears of rising long-term inflation, fueled by expanding fiscal deficits while the economy is close to full employment, and increased protectionism driving up costs.

The Dollar is likely to remain strong, with the Index expected to reach 120, as long as the US remains committed to preserving the Dollar’s status as the global reserve currency.

Gold is riding a secular wave, fueled by concerns over the sustainability of US federal debt, fears of long-term inflation, rising geopolitical tensions, and collapse of the domestic real estate market as an attractive investment for private Chinese savings. We expect this to last for decades, perhaps even longer. Our target for gold is $3,600 per ounce by 2028.

The only feasible long-term path to reduce federal debt relative to GDP is for the Fed to suppress interest rates. This would allow GDP fueled by inflation to grow at a faster rate than fiscal debt and gradually reduce the ratio of debt to GDP to sustainable levels. The inevitable negative real interest rates would further boost demand for gold.

Acknowledgments