Interest Rates Slump
Although the Fed is tapering … it’s still buying $45 billion in bonds per month. And minutes from the last meeting reveal that Fed members are now backing away from an exit strategy of selling Treasury and mortgage-backed securities to reduce its bloated balance sheet.
This about-face by the Fed helped push 10-year Treasury yields down to 2.6 percent recently from over 3 percent at the end of 2013. And it’s not only Treasury yields that are falling; nominal interest rates are in free-fall around the world:
* German bunds yield just 1.4 percent and French government bond yields fell to 1.65 percent — the lowest level since 1746!
* Two of Europe’s most troubled PIIGS, Spain and Italy, also have witnessed record low bond yields of 2.6 percent and 2.76 percent, respectively.
* Yield spreads on emerging market debt and junk bonds compared with Treasuries are likewise sinking toward new lows.
This compression in nominal yields around the global has important implications for investors and could prove very bullish for certain asset classes. Case in point: Gold.
Real Yields Sink
Historically, real interest rates (long term bond yields minus the inflation rate) have always had a very close, inverse correlation with the price of gold. In fact, it’s the single most predictive factor for gold prices.
When real rates fall, gold inevitably rises, and vice versa. As you can see in the chart below, real interest rates declined steadily after the financial crisis and Great Recession in 2008, and gold rose every step of the way.
But as you can see above, real yields began rising again in 2012, which continued last year. This corresponds almost perfectly with a sharp decline in gold prices, but recently real rates stopped rising and are now rolling over again, as you can see at the far right.
While interest rates around the world are declining steadily this year, inflation is beginning to edge higher.