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 jobs and falling crude = September rate cut

Key Points

  • The Fed will likely cut interest rates in September after a weak jobs report.
  • Falling crude oil prices also ease inflationary pressure.
  • Long-term Treasury yields fall, anticipating a rate cut.
  • The dollar weakened as yields softened, while gold soared to a new high of $3,600 per ounce.

The August labor report disappointed with a low 22,000 job growth compared to an expected 75,000. Another June data revision saw jobs contract by 13,000, after initial reported gains of 147,000 were revised down to 14,000 last month.

Employment Growth

Growth in total weekly hours worked came to a complete halt in August, with annual growth falling to 0.7%. Real GDP growth will likely follow.

Total Hours Worked

The uptrend in continued claims confirms the August rise in the unemployment rate to 4.3%.

Unemployment

The unemployment level ( 7.4m ) now exceeds job openings ( 7.2m ), but only by 200K.

Job Openings

Temporary jobs fell to 2.5 million, a level typically seen during recessions.

Temporary Employment

Layoffs and discharges are in an uptrend.

Layoffs & Discharges Rate

The 2.0% quit rate indicates that employees are no longer confident in finding new jobs.

Quit Rate

Average hourly earnings growth slowed to an annualized rate of 3.3% in August, but year/year growth was steady at 3.9%, still indicating a balanced labor market.

Average Hourly Earnings

Crude Oil

OPEC+ has injected a lot of downside pricing risk into the oil markets this week, fueling speculation that the second wave of voluntary cuts totaling 1.65 million b/d could be unwound much quicker than previously expected. According to news reports, Saudi Arabia is interested in pushing ahead with the unwinding during the September 7 meeting, citing the need to regain market share. (OilPrice.com)

The move has the potential to create a massive oversupply. Brent crude fell to $65.50 per barrel on Friday, but if the Saudis succeed, expect a test of support at $60. Falling crude prices would squeeze shale producer margins, causing a drop in US production.

Brent Crude

Lower energy prices would ease inflationary pressures in the US, allowing more room for Fed rate cuts.

ISM Services

The ISM services PMI improved to 52% in August, indicating expansion.

ISM Services PMI

New orders jumped to 56%, signaling an improving outlook.

ISM Services New Orders

However, services employment signals contraction, confirming the weak labor report.

ISM Services Employment

A steep 69.2% for the prices sub-index also warns of strong inflationary pressures.

ISM Services Prices

Contracting employment and rising prices in the large services sector warn of stagflation. We expect the Fed to cut in September, but then pause to see how this affects prices.

Stocks

A weak labor report is a bearish sign for stocks despite the prospect of a Fed rate cut. A reversal of the S&P 500 below support at 6400 would warn of a correction.

S&P 500

We expect the Dow Jones Industrial Average to test support at 45,000. Respect of support would confirm another advance. A breach is less likely, but would signal a test of 44,000.

Dow Jones Industrial Average

Financial Markets

The Chicago Fed Index retreated to -0.526, warning that financial conditions are tightening.

Chicago Fed National Financial Conditions Index

Tighter financial conditions are also highlighted by a decline in bank reserves to below $3.2 trillion.

Commercial Bank Reserves at the Fed

Bitcoin is testing support at 110K. A breach would warn of a swing to risk-off in financial markets, which would be bearish for stocks.

Bitcoin (BTC)

Treasury Markets

10-year Treasury yields plunged to 4.09%, heading for a test of long-term support at 4.0% as speculators pile into bonds ahead of the expected September rate cut. However, we have warned of the risk that long-term yields rise in response to a Fed cut — as in September last year.

10-Year Treasury Yield

Dollar & Gold

The dollar weakened in response to the poor jobs report, anticipating falling interest rates.

Dollar Index

Gold surged to a new high at $3,600 per ounce before closing at $3,587. Expect another test of support at $3,500, but respect will likely confirm another advance — and our year-end target of $4,000.

Spot Gold

Silver is retracing to test support at $40, but respect will likely confirm another advance and a target of $44.

Spot Silver

Conclusion

Weak jobs growth in August warns that economic growth is slowing, but the ISM services report warns of strong price pressures in the services sector. We expect a Fed rate cut in September but then a pause as the Fed remains wary of stagflation, with low growth and rising prices.

We expect the dollar to weaken in response to rate cuts, with gold and silver soaring to new highs.

The Fed should take care to avoid a repeat of last September, when Fed rate cuts sparked a sell-off in long-term Treasuries, signaling the bond market’s displeasure with monetary and fiscal policy. We believe they will aim for a gradual decline, with a pause after the September cut to assess the impact of tariffs and a slowing economy on prices.

A Saudi move to increase crude oil production would likely drive Brent crude to $60 per barrel or below, giving the Fed more room to cut rates.

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

Rising recession risk threatens bond market

Summary

  • Trade talks with China have stalled
  • President Trump announces steel and aluminum tariffs will increase from 25% to 50%
  • Input costs for US manufacturers are expected to soar
  • Spending is expected to slow after the introduction of tariffs in April
  • The economic outlook is clouded with uncertainty, and the risk of a recession is rising

President Trump accused China of “totally violating its agreement” with the United States last week. (Reuters)

The Geneva agreement concluded between Treasury Secretary Bessent and his Chinese counterpart called for a 90-day pause in increased tariffs and for China to lift restrictions on exports of critical materials such as rare earths needed for semiconductor, electronics, and defense applications.

According to a US trade representative, the Chinese are moving slowly on granting export licenses for critical materials. The automobile industry is already warning that shortages of rare earth magnets could halt production in a matter of weeks.

The Chinese slow-walking of export licenses appears to be retaliation for the US last week imposing license requirements, and revoking some licenses, for exports of design software and chemicals for semiconductors, butane and ethane, machine tools, and aviation equipment.

In another blow to the auto industry, President Trump announced that he will increase tariffs on steel and aluminum imports from 25% to 50%. Steelmakers are expected to benefit from higher domestic prices, boosting output, but automobile manufacturing, heavy engineering, and construction industries will likely bear the costs.

Steel exports from Canada and Mexico will be most affected, but South Korea, Germany, and Brazil are also expected to suffer. The EU has threatened retaliatory measures if the issue cannot be resolved.

Aluminum imports are likely to continue despite the increased tariffs. Bauxite and electricity are the two primary input costs of smelters, and domestic US smelters will struggle to match the low-cost hydroelectric power of global competitors.

Financial Markets

The S&P 500 is testing the band of resistance at 6000, but short weekly candles indicate hesitancy.

S&P 500

Strong liquidity supports financial markets, with the Chicago Fed National Financial Conditions Index falling to -0.606, signaling easy monetary conditions.

Chicago Fed National Financial Conditions Index

10-year Treasury yields are testing support between 4.4% and 4.5%, but the weak dollar warns of capital outflows that are expected to send long-term yields higher.

10-Year Treasury Yield

JPMorgan CEO Jamie Dimon says, “You are going to see a crack in the bond market. It is going to happen…. I’m telling you it’s going to happen….”

Economy

Former Fed economist Dr Lacy Hunt warns that the US economy is slowing, with a higher than 50% probability of recession. He warns that the economy is far weaker than generally understood, and what markets are not considering is that spending brought forward to front-run tariffs is likely to cause a sharp drop in spending in the next few months.

A recession would also cause the fiscal deficit to increase sharply, by at least another 2.0% of GDP, adding further stress on the bond market.

The ISM manufacturing PMI declined to 48.5% in May, indicating a long-term contraction.

ISM Manufacturing PMI

Manufacturing inventories surged in March as manufacturers brought forward purchases to get ahead of April’s tariff increases.

ISM Manufacturing Inventories

Imports also surged in the first quarter, followed by a steep plunge in May.

ISM Manufacturing Imports

Exports are contracting at a similar rate.

ISM Manufacturing Exports

Prices is the only sub-index that has surged, warning of steeply rising input costs.

ISM Manufacturing Prices

Crude Oil

OPEC+ decided to increase production targets by 411.000 barrels per day in July, which is equal to the increases in May and June.

However, in a sign of shrinking global trade, China’s seaborne imports declined by more than a million barrels per day in May. Kpler estimates imports at 9.43 mbpd compared to 10.46 mbpd in April and 10.45 mbpd in March. (Reuters)

Brent crude is likely to re-test support at $60 per barrel, and breach would offer a target of $50.

Brent Crude

Dollar & Gold

Capital outflows are weakening the dollar. The US Dollar Index has broken support at 100, and follow-through below 98 would confirm another decline with a target of 90.

Dollar Index

Gold rallied to test the band of resistance at $3,400 per ounce. A breakout above $3,500 would strengthen our target of $4,000 by the end of 2025.

Spot Gold

Conclusion

Due to high levels of uncertainty, consumers and corporations are expected to defer capital expenditures in the months ahead. The drop in spending is likely to be accelerated by the build-up in inventories and the bringing forward of expenditures to get ahead of tariff increases in April.

Contracting imports and exports in the manufacturing sector warn that the economy will slow. Falling crude oil imports in China paint a similar outlook, suggesting a global recession.

A recession would increase the deficit and further stress the bond market, which is already concerned about spiraling debt levels.

A falling dollar and rising gold price warn of capital outflows from US financial markets. JPMorgan CEO Jamie Dimon tells us to prepare for a coming crack in the bond market. That would mean higher long-term yields and sharply lower stock prices, likely boosting demand for gold even higher.

Acknowledgments

Inflation dips?

The 10-year Treasury yield retreated after the release of December CPI data, with breach of the rising trendline signaling a correction to test support at 4.5%.

10-Year Treasury Yield

However, the monthly chart below shows the long-term uptrend is unchanged, with the 10-year yield expected to reach 5.0%. Breakout above resistance would warn of an advance to 6.0%.

10-Year Treasury Yield

CPI Inflation

Core CPI (ocher) dipped slightly to 3.2% for the twelve months to December, while headline CPI (red) increased to 2.9%, holding stubbornly above the Fed’s 2.0% target.

CPI & Core CPI - Annual

Monthly data shows a sharp spike in headline CPI in December, increasing at an annualized rate of 4.7%. Core CPI, however, slowed to 2.7% (annualized).

CPI & Core CPI - Monthly

Energy

The difference is energy costs, excluded from core CPI, which jumped 2.63% in December, warning of rising energy prices in 2025. The December increase equates to an annualized rate of more than 30%.

CPI Energy

Energy prices are a key vector for transmitting inflation. Prices rise steeply during a boom as expanding demand outstrips inelastic supply, and the opposite occurs during a recession when falling energy demand causes a surplus. Energy prices (orange below) rose ahead of headline CPI (red) in 2021 and fell ahead of its subsequent decline in 2022 – 23.

CPI & CPI Energy - Annual

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Services

CPI for services (excluding shelter) was a low 0.099% in December or 1.2% annualized. Services generally indicate more persistent inflation, so the Fed will likely treat this as a win.

CPI Services excluding Shelter Rents

Long-term Inflation Outlook

Long-term inflation expectations are rising, with the University of Michigan 5-year outlook climbing to 3.3%.

University of Michigan: 5-Year Inflation Expectations

We do not anticipate a significant hike in CPI in early 2025, but there are warning signs of a rebound.

Brent Crude

Brent crude has climbed to above $80 per barrel on fears that new sanctions on Russian shipping will impact supply. Retracement that respects support at $80 would confirm another advance.

Brent Crude

Stocks

Mega-cap technology stocks rebounded from yesterday’s fall, with the two most volatile Nvidia (NVDA) and Tesla (TSLA) showing gains.

Top 7 Technology Stocks

The S&P 500 index recovered above resistance at 5850, indicating another test of the high at 6100.

S&P 500

Large caps also enjoyed support, with the equal-weighted index ($IQX) testing resistance at 7200. Breakout would indicate another test of 7600.

S&P 500 Equal-Weighted Index

Growth stocks rebounded from their recent sell-off relative to defensive stocks. However, the Russell 1000 Large Cap Value ETF (IWD) has outperformed the Russell 1000 Large Cap Growth ETF (IWF) over the past month.

Russell 1000 Large Cap Value ETF (IWD) & Russell 1000 Large Cap Growth ETF (IWF)

Financial Markets

Bitcoin is again testing resistance at $100K. Reversal below $90K would warn of a liquidity contraction likely to affect stocks and bonds, but there are signs that financial conditions are easing. Breakout above $100K would confirm.

Bitcoin (BTC)

Expanding liquidity is partly attributable to a $350 billion fall in Fed overnight reverse repo operations in January after an equally sharp rise in December caused a contraction.

Fed Overnight Reverse Repo Liabilities

The Chicago Fed National Financial Conditions Index declined to -0.63 on January 10, suggesting similar financial easing to 2021.

Chicago Fed National Financial Conditions Index

Moody’s Baa corporate bond spread has also narrowed to 1.44%, the lowest since the 1990s, which indicates ready credit availability.

Moody's Baa Corporate Bond Spreads

Gold

Fears of persistent inflation drive gold and geopolitical tensions fuel further demand. A higher Trend Index trough indicates rising buying pressure and a breakout above $2,725 per ounce would signal another test of $2,800.

Spot Gold

The monthly chart below shows the long-term view, where breakout above resistance at $2,800 (green) would offer a target of $3,600.

Spot Gold

Conclusion

Our three pillars supporting financial markets are 10-year Treasury yields, crude oil prices, and financial market liquidity.

Financial market liquidity is strong and supports demand for stocks and bonds with easy access to leverage.

Crude oil prices have been subdued since 2023, with strong production from non-OPEC+ producers (especially the US) and weak demand from China. However, geopolitical tensions now threaten supply, with Brent crude rising above $80 per barrel. The risk is that higher energy prices cause a resurgence of inflation and drive up long-term interest rates.

Inflation concerns over a tight labor market were temporarily allayed by December’s weak core CPI and services CPI growth. However, rising energy costs will likely increase input costs, causing a rebound in the months ahead. Market concerns over inflation are expected to grow as the incoming administration attempts to stimulate an economy already at close to capacity. The 10-year Treasury yield may briefly retrace to test support but is then likely to continue its long-term uptrend. Breakout above 5.0% would offer a target of 6.0%, which would be bearish for stocks and bonds.

We are underweight growth stocks trading at high earnings multiples and are avoiding financial instruments with a duration longer than two years.

Gold will likely benefit from a higher long-term inflation outlook and rising geopolitical tensions. We are overweight gold and defensive stocks trading at reasonable multiples relative to earnings.

Acknowledgments

Inflation fears threaten higher interest rates

Markets are hesitant ahead of December CPI data due for release in a few hours.

Fearful of a resurgence in inflation, Treasury investors are driving up long-term interest rates, with the 10-year yield headed for a test of 5.0%.

10-Year Treasury Yield

Long-term inflation expectations are rising, with the University of Michigan 5-year outlook climbing to 3.3%.

University of Michigan: 5-Year Inflation Expectations

Producer prices are also rebounding, with services PPI recovering to 4.02% in December.

PPI Services

We do not anticipate a significant hike in CPI, but there are warning signs of a rebound.

Brent Crude

Brent crude climbed to $80 per barrel on the threat of new sanctions on Russian shipping impacting supply. Retracement that respects support at $76 would warn of another advance.

Brent Crude

Energy prices are a key vector for inflation. The chart below shows how energy CPI (orange) rose ahead of headline CPI (red) in 2021, and its fall in 2022 – 23 was instrumental in inflation’s subsequent decline.

Energy CPI & Headline CPI

Stocks

Mega-cap technology stocks are dragging the S&P 500 down, with former frontrunner Nvidia (NVDA) falling 7.2% over the past two months. Tesla (TSLA) has also shed almost half its December gains.

Top 7 Technology Stocks

The S&P 500 index is retracing to test resistance at 5850. Respect would warn of a further decline to 5700.

S&P 500

Large caps enjoy more support, with the equal-weighted index ($IQX) respecting key support at 7000.

S&P 500 Equal-Weighted Index

Rising long-term interest rates have set off a migration from high-multiple growth stocks to more defensive value sectors, with the Russell 1000 Large Cap Value ETF (IWD) outperforming the Russell 1000 Large Cap Growth ETF (IWF) in the past few weeks.

Russell 1000 Large Cap Value ETF (IWD) & Russell 1000 Large Cap Growth ETF (IWF)

Financial Markets

Bitcoin struggles to break resistance at $100K as financial market liquidity tightens. A reversal below $90K would warn of a liquidity contraction likely to affect stocks and bonds.

Bitcoin (BTC)

Gold

Fears of persistent inflation drive gold and geopolitical tensions fuel further demand. A higher Trend Index trough indicates rising buying pressure and a breakout above $2,725 per ounce would signal another test of $2,800.

Spot Gold

The monthly chart below shows the long-term view, where breakout above $2,800 would offer a target of $3,600.

Spot Gold

Conclusion

Rising long-term Treasury yields reflect the growing risk of long-term inflation.

The outlook is bearish for growth stocks trading at high earnings multiples and financial instruments with a duration longer than two years.

We remain bullish on gold and defensive stocks.

Acknowledgments

The last guardrail

In the above ABC interview, Professor Nouriel Roubini said it would be interesting to watch Trump deal with financial markets:

He said if Trump was “really serious” about 60 per cent tariffs on China, and 10 to 20 per cent tariffs on other trading partners, about sharply weakening the value of the US dollar, about “draconian restrictions” on migration and “mass deportation”, and about tax cuts that weren’t funded by raising other taxes or cutting spending, it could lead to situations Trump wouldn’t like.

“If he tries to follow these policies that are stagflationary, interest rates are going to be much higher, bond yields are going to be higher, the Fed will have to raise rates rather than cutting them, the stock market is going to correct,” he said.

“He cares about the bond market. He cares about the stock market. And therefore market discipline, as opposed to political discipline … [will] be the main constraint [for him].”

Long-term Treasury bonds continued their downtrend after November 5.

iShares 20+Year Treasury Bond ETF

Ten-year yields are testing resistance at 4.5%. A breakout above 4.5% would likely cause a correction in stocks.

10-Year Treasury Yield

Fears of rising inflation are not the only factor driving Treasury yields higher. Since 2020, Treasury issuance has been skewed towards short-dated T-bills, with the issuance of notes and bonds (green) kept as low as possible to suppress long-term yields.

Treasury Issuance

A study by Hudson Bay Capital concluded that rolling back the excess $1 trillion in T-bill issuance would cause a 50 basis point rise in the 10-year yield—equivalent to a 2.0% rise in the Fed funds rate—before settling at a permanent 30 basis point increase.

Also, Fed QE almost exclusively focused on purchasing notes and bonds to keep long-term yields as low as possible. Reducing the Fed’s balance sheet through QT increases the supply of notes and bonds, driving long-term yields higher.

Fed Holdings of Treasury Notes & Bonds and T-bills

Rising long-term yields constrain the S&P 500, which is testing support at 5850. Breach would signal a correction to 5700.

S&P 500

Financial Markets

Bitcoin remains above 90K, signaling strong liquidity in financial markets.

Bitcoin (BTC)

Dollar & Gold

The Dollar index retraced to test support at its rising trendline, but breakout above 107 remains a threat, offering a target of 115.

Dollar Index

Gold rallied off support at $2,550 per ounce. Penetration of the descending trendline at $2,650 would indicate a base forming.

Spot Gold

Silver similarly found support at $30 per ounce.

Spot Silver

Energy

Brent crude remains in a bear market, which is likely to keep inflation in check as long as global demand remains subdued.

Brent Crude

Base Metals

Copper also reflects weak global demand, with another likely test of support at $8,600 per tonne.

Copper

Conclusion

Donald Trump’s election campaign was based on reviving a “weak” economy, which has proved surprisingly resilient. The Fed and Treasury succeeded in taming inflation without crashing the economy—a rare feat. However, their efforts have built up imbalances in the financial system that lie in wait for the unwary.

Stimulating an economy already close to full employment will inevitably cause higher inflation, preceded by a surge in long-term Treasury yields. The result would be a sharp fall in stock prices and a likely recession.

The Republican party may control the House and the Senate, but the final guardrail is the bond market. They ignore that at their peril.

Gold and silver fell as the Dollar soared in response to higher long-term Treasury yields. But yields are rising in anticipation of rising inflation. We remain bullish on gold and retain our $3,000 per ounce target.

Acknowledgments

S&P 500 makes new high

Bond markets were closed Monday for Columbus Day, but financial market conditions show further signs of easing. Equities powered ahead, with the S&P 500 making a new high at 5859.

Stocks

The S&P 500 broke resistance at 5800, strengthening commitment to our target of 6000 by year-end. Rising Trend Index troughs signal long-term buying pressure.

S&P 500

The advance is broad, with the equal-weighted index ($IQX) breaking resistance at its previous high of 7300. This offers a target of 7500.

S&P 500 Equal-Weighted Index

Financial Markets

Moody’s Baa corporate bonds spread narrowed to 1.54%, signaling ready availability in credit markets.

Moody's Baa Corporate Bond Spreads

Bitcoin also broke above its six-month trend channel, signaling strong liquidity in financial markets.

Bitcoin (BTC)

Dollar & Gold

The Dollar Index continues to strengthen as Treasury yields rise. This may seem counterintuitive, given the prospect of further rate cuts ahead, but the strong September jobs report has increased bond market concerns about an inflation recovery.

Dollar Index

Gold found support at $2,600 per ounce but has hesitated at $2,650. A lower Trend Index peak would warn of another test of support at $2,600. The Shanghai Gold Exchange no longer trades at a premium, with the iAu99.99 contract quoted at 605.04 RMB/gram, equivalent to $2,643 per ounce at the current exchange rate of 7.12 CNY to the Dollar.

Spot Gold

Silver is also hesitant, testing short-term support at $31 per ounce.

Spot Silver

Crude Oil

Brent crude is retracing to test support at $76 per barrel after Israel confirmed they would not strike Iranian oil targets and OPEC cut their oil demand forecast for 2024 and 2025.

Brent Crude

Brent [crude] fell 5%, or more than $4, in after-hours trading following a media report that Israeli Prime Minister Benjamin Netanyahu told the U.S. that Israel is willing to strike Iranian military targets and not nuclear or oil ones…..

OPEC on Monday cut its forecast for global oil demand growth in 2024 and also lowered its projection for next year, marking the producer group’s third consecutive downward revision. China, the world’s largest crude oil importer, accounted for the bulk of the 2024 downgrade as OPEC trimmed its growth forecast for the country to 580,000 barrels per day (bpd) from 650,000 bpd. China’s crude imports for the first nine months of the year fell nearly 3% from last year to 10.99 million bpd, data showed. Declining Chinese oil demand caused by the growing adoption of electric vehicles (EV), as well as slowing economic growth following the COVID-19 pandemic, has been a drag on global oil consumption and prices. (Reuters)

Base Metals

Copper is testing short-term support at $9,500 per tonne after it respected resistance at $9,900. Breach of support would offer a target of $9,250.

Copper

Aluminum similarly retreated from resistance at $2,650 per tonne and will likely test support at $2,500.

Aluminum

China’s deflationary pressures also worsened in September, according to official data released on Saturday. A press conference the same day left investors guessing about the overall size of a stimulus package to revive the fortunes of the world’s second-largest economy.

“The lack of a clear timeline and the absence of measures to address structural issues, such as weak consumption and reliance on infrastructure investments, have only increased ambiguity amongst market participants,” noted Mukesh Sahdev, the global head of commodity markets-oil at Rystad Energy. (Reuters)

Iron Ore

Iron ore is expected to retrace to test support at $100 per tonne following a sharp rise after China’s stimulus announcement.

Iron Ore

Conclusion

Financial markets show signs of a promising rise in liquidity, with falling corporate bond spreads and Bitcoin breakout above its six-month trend channel. The S&P 500 responded with breakout above 5800, strengthening our commitment to a target of 6000.

Gold and silver display strong uptrends but hesitate in response to a rising Dollar. Increased fears of an inflation rebound are behind the recent rally in long-term Treasury yields and the Dollar. We expect the uptrend in gold and silver to continue, with low real interest rates, whether or not inflation fears fade.

We expect that China will struggle to recover from its current economic slump. The announced stimulus program remains vague and does not address the underlying issue of weak domestic consumption. Deflationary pressures will likely keep a lid on crude oil and industrial metal prices for several years.

Low crude oil prices are also likely to keep inflation in check, leading to low long-term interest rates in the West.

Acknowledgments

China sizzle turns to fizzle

China’s announcement of economic stimulus and hints at an even larger “bazooka” ahead caused a sizzling rally on the Shanghai exchange, with the CSI 300 leaping 20% in the last week of September.

Shanghai Shenzhen CSI 300 Index

Hong Kong’s Hang Seng Index displays an even steeper rally.

Hang Seng Index

However, a failure to follow through this week with sufficient detail of the stimulus package caused the rally to fizzle, with a sharp correction on both indices. Today, the Hang Seng is testing support at 20500.

China Stimulus

Crude Oil

Brent crude reversed sharply as prospects faded for a demand recovery in China.

Brent Crude

Treasury Markets

Ten-year Treasury yields stalled and will likely re-test new support at 4.0%.

10-Year Treasury Yield

According to the theory of interest developed by Swedish economist Knut Wicksell, the equilibrium or natural rate of interest—at which inflationary and deflationary pressures are in balance—is when the cost of borrowing is higher than the average return on new investment. This means that the 10-year Treasury yield–the risk-free rate–should be roughly equal to nominal GDP growth, approximating the return on new investment. The chart below shows that the 10-year Treasury yield, at 4.0%, is significantly lower than nominal GDP growth of 5.7% for the 12 months ended in Q2.

Wicksell Analysis: Nominal GDP Growth & 10-Year Treasury Yield

With the economy showing little sign of slowing, the likely outcome is either higher long-term interest rates or a build-up of long-term inflationary pressure.

Stocks

The S&P 500 gained almost 1.0% on Tuesday, with a shallow retracement and rising Trend Index troughs signaling buying pressure.

S&P 500

Nvidia led the advance of mega-cap stocks, breaking above its August high, while all seven advanced yesterday.

Top 7 Technology Stocks

The equal-weighted index lagged as large caps failed to match mega-cap gains.

S&P 500 Equal-Weighted Index

Financial Markets

Bitcoin continues to test the upper border of its trend channel. A breakout would be a bullish sign for financial market liquidity.

Bitcoin (BTC)

Dollar & Gold

The Dollar Index is expected to retrace to test new support at 102. Respect would confirm an advance to 104.

Dollar Index

Gold is headed for a test of support at $2,600 per ounce, but respect will likely confirm a re-test of $2,700.

Spot Gold

Silver is testing support at $30 per ounce, with respect again likely to signal a re-test of resistance at $32.

Spot Silver

Metals

Copper retreated in response to China’s disappointing stimulus. Expect a correction to test support at $9,250 per tonne.

Copper

Iron ore also reflects disappointment, retreating to $106.30 per tonne.

Iron Ore

Conclusion

A disappointing lack of detail on China’s newly announced stimulus led to a retreat in Chinese stocks and global crude oil, copper, and iron ore.

Ten-year Treasury yields are expected to retrace to test support at 4.0%. While yields are likely to remain low as the Fed cuts interest rates, the long-term equilibrium rate is expected to be higher—between 5% and 6%.

Respect of support at 5650 on the S&P 500 confirms our year-end target of 6000, but the advance is exceedingly narrow and precarious.

Gold is headed testing support at $2,600 per ounce, but respect is likely and would signal a re-test of $2,700.

Acknowledgments

Houthis and the blow-back

Stocks retraced to test support on concerns over an escalation of hostilities between Israel and Iran and its potential threat to the flow of crude oil from the Middle East.

Stocks

The S&P 500 retraced to test support at 5670/5700, but rising Trend Index troughs signal buying pressure. Respect of support will likely confirm another advance, with a target of 6000.

S&P 500

The equal-weighted index ($IQX) shows that large caps experienced a similar retracement.

S&P 500 Equal-Weighted Index

Financial Markets

Bitcoin is consolidating in a narrow “descending flag” channel. Marginally lower troughs are typically a bullish sign, reflecting support. Upward breakout from the channel would signal a fresh advance, confirming strong liquidity in financial markets.

Bitcoin (BTC)

Treasury Markets

Increased demand for safety drove 10-year Treasury yields lower, again testing support at 3.7%.

10-Year Treasury Yield

Dollar & Gold

The Dollar strengthened, benefiting from the same flight to safety.

Dollar Index

Gold retraced to test support, but the flight to safety will likely fuel another rally, breaking resistance at $2,700 per ounce.

Spot Gold

Silver found short-term support at $31 per ounce and will likely re-test long-term resistance at $32.

Spot Silver

ISM Manufacturing

The ISM Manufacturing PMI continues to signal contraction, holding steady at 47.2%.

ISM Manufacturing PMI

The New Orders sub-index at 46.1% warns of further slowing ahead.

ISM Manufacturing New Orders

So does the Employment sub-index at 43.9%.

ISM Manufacturing Employment

The Prices sub-index surprised, dropping below 50% for the first time since the beginning of the year, reflecting declining inflationary pressures.

ISM Manufacturing Prices

Labor Market

Job Openings also surprised, increasing to 8.04 million in August. The gap above unemployment indicates continued labor market tightness.

Job Openings

Crude Oil

Brent crude is rallying on fears of an interruption to oil supplies from the Middle East.

Brent Crude

Conclusion

Escalation of hostilities between Israel and Iran is likely to fuel a flight to safety, increasing demand for Treasuries, gold, and silver.

We expect the S&P 500 to retrace to test support at 5670. Crude oil is likely to rally but remain in a bear market unless Iran attempts to interdict shipping in the Straits of Hormuz and the Red Sea through its Houthi proxies in Yemen.

The ISM PMI warns of a slowing manufacturing sector, but there has been no significant decline in cyclical sector employment so far. Job openings also maintain a healthy gap above unemployment, indicating a still-tight labor market. The economy is expected to remain reasonably robust until the new year, when liquidity may tighten as the US Treasury likely reduces T-bill issuance, replacing them with longer-term coupons.

Acknowledgments