US Fed pivot in focus: Why are gold prices following US Treasury yield? — Explained

The US Federal Reserve's supersized interest rate cut by 50 basis points (bps) or (½) half a percentage point has triggered a robust rally in several commodity baskets, particularly gold prices, lifting its demand optimism. The much-awaited US Fed pivot has resulted in the US dollar and US Treasury yield being inversely proportional to gold prices. According to market experts, gold prices often follow US Treasury yields because of the inverse relationship between yields and the yellow metal's opportunity cost.

The one-year US bond yield is higher than the 10-year, at 3.98 per cent, and the 10-year, at 3.77 per cent. When Treasury yields rise, especially in the short term, investors may prefer bonds over gold, a non-yielding asset. However, amid the US Fed rate cut scenario, gold prices seem to follow the US Treasury yield's movement in direction, inverting their relationship. 

Also Read: Gold Prices Today: Yellow metal hits record-high at $2645/oz on US Fed rate cut, MCX above ₹7,4900/10 gms

Why are gold prices following US Treasury yields?

The fact that the one-year bond yield is higher than the 10-year indicates an inverted yield curve, signalling potential recessionary concerns. This inversion generally leads investors to seek safe havens like gold, supporting higher gold prices as they hedge against economic uncertainty.

Treasury bonds offer a guaranteed return. When yields rise, the opportunity cost of holding gold, which doesn't pay interest, increases. Investors may be more inclined to sell gold and invest in higher-yielding bonds. US Treasury yields often indicate forecasts for future interest rate changes by the US Federal Reserve. 

According to Jateen Trivedi, VP Research Analyst - Commodity and Currency, LKP Securities, “After the US Fed rate cut became clear, the US dollar and US Treasury Yield remained inversely proportional to gold prices. As long as US Fed rate cuts are expected, the trend of an inverse relationship between Treasury yields, the US dollar, and gold prices will likely continue.”

An interest rate cut will reduce yields and weaken the US dollar, making the yellow metal more attractive to investors. However, if inflationary pressures or stronger-than-expected economic data emerge, this could temporarily disrupt the trend and pressure gold prices.

Also Read: Gold price gains on rate cut optimism, geopolitical tensions; experts point out key levels for MCX Gold 

‘’A fall in government bond yields increases interest in gold as an alternative to capital preservation, all other things being equal. This inverse correlation worked well last year but has started to fail this year and broke down this week when gold prices and yields started to rise simultaneously. If this is not a sign of a flight from dollar assets, it may be a sign that gold is nearing a peak.

The forced liquidation of short positions may push the gold price higher into historical highs, as the US dollar generally holds its ground against a basket of major currencies, and rising bond yields create an unfavourable environment for gold,'' said Alex Kuptsikevich, Senior Market Analyst at FxPro.

Most analysts believe that the inverse correlation between gold prices, the US dollar, and Treasury yields will endure for the foreseeable future. The recent Fed rate drop signalled a dovish stance, implying that the Fed is concerned about economic growth and inflation. 

“This will result in a weaker US dollar, which will support the gold price. Also, as interest rates on US T-bonds fall, the opportunity cost of holding gold decreases. This may make gold more appealing to investors as a feasible store of value,” said Aamir Makda, Commodity & Currency Analyst, Choice Broking.

Gold has jumped 27 per cent in 2024, with prolonged conflicts in the Middle East adding to safe-haven demand. Analysts still maintain that price volatility is expected ahead of various US inflation data releases, and traders should watch these levels for potential movements.

‘’While US Treasuries and gold generally share a negative correlation, recent periods of uncertainty—driven by war, economic slowdown, currency instability, an overvalued stock market, and recession fears—have inverted this relationship. China’s economy, despite massive stimulus efforts and rate cuts, is struggling to show significant recovery. The US remains burdened by escalating debt, and inflation is still far from the Fed’s two per cent target," said Pranay Aggarwal, CEO, Stoxkart – a discount broker.

Also Read: US Fed delivers supersized 50 bps rate cut: FPI inflows to stronger INR—here’s how the verdict is ‘good’ for India

Gold price outlook

According to domestic brokerage SMC Global Securities, in recent months, the focus has shifted to the Federal Reserve’s policies and the outlook for the US economy. Gold thrives as a safe-haven asset in a low-rate environment, particularly amid recessionary fears. Tensions in the Middle East have also contributed to safe-haven demand for gold. COMEX gold looks strong, with a potential target of $2,700 and support near $2,520. 

“Our outlook on gold continues to remain bullish. Globally, countries are moving away from US bonds and into gold and other hard assets. If we notice, China’s holding of US treasury bonds is at decadal lows, and gold at all-time highs. We see this trend continuing over the medium term--of selling treasuries and buying gold," said Kunal Mehta, Associate Director at Equirus.

Also Read: Gold rate today: Yellow metal jumps; can it sustain gains? Experts unveil strategy for MCX Gold price 

Commodity analysts reckon that with the US presidential election looming in November 2024, geopolitical tensions and expectations of a further 50-basis-point rate cut by the US Federal Reserve this year, the outlook for gold remains bullish. The Fed has also hinted at a potential one per cent rate cut in 2025. Interest rate cuts typically weaken the dollar and lower bond yields, making gold a more appealing investment.

Aamir Makda of Choice Broking anticipates a moderately bullish trend in gold prices in the upcoming weeks. Key support levels would be at 71,500 – 67,400. On the other hand, hurdles would be at 76,700 - 78,000 on the higher side. According to the analyst, traders may look forward to any correction in price as a long opportunity in gold.

“ETF and investment flows into gold are increasing, reflecting growing investor confidence. Given this favourable environment, gold could hit $3,000 in the coming months,” said Pranay Aggarwal of Stoxkart.

US Federal Reserve policy verdict

The US Federal Reserve announced its sixth policy decision for 2024 last week after a two-day Federal Open Market Committee (FOMC) meeting. For the first time in four years, it slashed the benchmark interest rate by 50 bps to 4.75 per cent-5 per cent, broadly in line with Wall Street estimates.

US Fed policymakers see the benchmark interest rate falling by another half-point (50 bps) by the end of this year, another full percentage point in 2025, and a final half-point reduction in 2026 to end in a 2.75 per cent-3.00 per cent range. One bps is equal to one hundredth (1/100) of a percentage point.

Also Read: US Fed lowers policy rate by 50 bps from 23-year high, signals additional 50 bps cuts; 5 key takeaways

The US central bank maintained the key borrowing rate elevated at the 23-year high for 14 consecutive months since July 2023 to combat the worst inflation outbreak in almost 40 years. In its policy statement, the Fed policymakers said FOMC gained greater confidence that inflation is moving sustainably toward the two per cent target level. It added that “risks to achieving its employment and inflation goals are roughly balanced."

Disclaimer: The views and recommendations provided in this analysis are those of individual analysts or broking companies, not Mint. We strongly advise investors to consult with certified experts before making any investment decisions, as market conditions can change rapidly and individual circumstances may vary.