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Sudden Sell-off in JGB’s puts a lid on Gold Rally


Aug 08, 2016

     As 2015 came to a close, most traders expected that 2016 would be a year dominated by a series of Fed rate hikes. That conviction solidified in late-December ’15; after the Fed delivered on its promise – and raised interest rates for the first time in almost a decade. In a widely telegraphed publication called the “Dots Plot,” the Fed signaled that it would continue to normalize its monetary policy, and raise interest rates by a total of +1% thru 2016; to a target of 1.375%, at a “gradual” pace and in line with previous projections.

     On Dec 21, 2015; the Atlanta Fed chief Dennis Lockhart said;  “Moving up gradually means not at every meeting, in all likelihood,” Lockhart said in an interview on WABE radio in Atlanta. The more probable pace of upcoming hikes “will be more like every other meeting,” Lockhart said, adding that he does not expect the turn toward higher rates to “snuff out” economic growth.

    On Jan 4th, San Francisco Fed chief John Williams said he saw a steady campaign of interest rate rises. “There are still pretty significant headwinds” facing the US economy from weak overseas economies, the strong dollar and housing related issues, Mr. Williams told reporters. The most likely outlook for the nation means the Fed should “still have a foot on the gas in 2016” with low interest rates, he said. But it should also be “progressively taking it back” with a gradual course of rate rises. When it comes to short-term rate increases, “I could easily see it be three or five or more or less depending” on what happens with the economy, he said.

     On January 6, 2016 – Fed deputy Stanley Fischer warned the markets could expect three to four increases in the fed funds rate this year. Speaking on CNBC television Fischer warned; “If asset prices across the economy — that is, taking all financial markets into account — are thought to be excessively high, raising the interest rate may be the appropriate step,”

     Based on expectations of 4-Fed rate hikes to 1.375% by year’s end, Gold initially declined in the month of December to a six year low at $1,054 /oz. Most analysts on Wall Street figured the declines would continue thru 2016. However, as fate would have it, they were decidedly wrong.

    Even though inflation — considered a cornerstone to Gold’s popularity — remained in check throughout much of the developed world, -the price of Gold suddenly surged +16% higher in the first quarter alone. It was the strongest quarterly performance in nearly three decades. The World Gold Council officials attributed the rally to three principal factors: 1- the widening landscape of negative interest rates in Japan and Europe, 2- the devaluation of China’s yuan; and 3- the realization that the Fed was bluffing on hiking the fed funds rate, and wouldn’t dare take any action that could knock the US-stock market lower, ahead of the upcoming Nov 8th elections in the US for Congress and the Presidency. 

     As such, by June 2016; all of Switzerland’s government debt, including its 30-year bonds, started trading at negative yields. In all, a record US$11.7 trillion of global sovereign debt has dipped to sub-zero yield territory. This has only strengthened rally for Gold, and about US$13-14 billion of money have made their way into gold exchange traded funds as asset managers moved from fixed income into gold earlier this year, The world’s largest Gold-backed exchange-traded fund, SPDR Gold Shares <GLD>, surge in its holdings to the most in six years . They jumped 29-tonnes to 983-tonnes, their highest since June 2013. Global gold holdings in ETFs topped 2,000 metric tons for the first time since June 2013 following the Brexit fallout, when gold buying has sparked even more gold buying. Global assets in the funds have surged 37 percent this year The People’s Bank of China increased assets +59- million ounces, or about 1,823 metric tons,

    Gold climbed to a two-year high at $1,371 /oz; in July, convincing UBS Group to predict that Gold is probably at the beginning of its next bull run. On June 30th, Bank of England chief Mark Carney said the economic risks from Brexit had started to crystallize, and he hinted at a rate hike and a resumption of QE, and lifted Gold to its biggest one day surge in years, Gold jumped as much as +8% versus the US$; to its highest in more than two years , after Britons shocked markets by voting to leave the European Union, driving investors toward safe-haven assets such as bullion. The Gold price in sterling jumped +20% to more than £1,000 at one point, before settling back to around £940,

    Now the Gold bulls in the year 2016 have bought enough equity style trading in gold in ETFs that they own more than all but 4 nations’ central banks and one global agency. Reports are circulating that the global gold holdings in exchange traded funds have now gone above 2,000 metric tons for the first time in three years. 

    However, Gold’s spectacular rally found a stiff roadblock at the $1,370 /oz area, – when Japanese government bonds suddenly began to fall sharply into their worst sell-off in 13 years. On August 2nd, – the Bank of Japan shocked the markets and rattled Gold traders by keeping its bond purchases steady, defying expectations it would buy even more. Gold traders became even more nervous after the BoJ said it would re-evaluate its Negative Interest Rate and QQE policies in September. Some investors see the policy review as a tacit admission by the central bank that after more than three years of massive money printing, the BoJ could be ready to start tapering the pace of the QQE liquidity injections.

    With an interest cut seen as off the table, shorter term Japanese interest rates surged +20-bps higher. The 10- year Japanese bond yield suddenly jumped +20-basis points higher; to its highest
since mid-March and up 26 bps from a record low of minus 0.38% less than a week ago. Traders began to wonder if the BoJ’s ‘whatever it takes’ as ‘monetary policy’s pretty had played out.” If the BoJ moves to a policy of buying stock indexes, and begins reduce its purchases of JGB’s , markets will interpret it as tapering. If that happens, the 10-year JGB yield could move upward into the positive territory.

     Since the $10.4-trillion bond market in Tokyo is at the epicenter of the the negative interest rate world, if the BoJ begins to allow Japanese bond yields to climb by tapering its QE scheme, it could continue to rattle the price of Gold, – at least on a short-term basis.  BoJ policy makers ordered staff to make a “comprehensive assessment” on the impact of its easing program and negative interest-rate policy ahead of the next policy-setting meeting on Sept. 20–21st. Some traders suspect the review is aimed specifically at assessing the effectiveness of negative rates, potentially giving policy makers scope to declare the exercise unsuccessful. On the other hand, policy makers may be looking for a broader assessment of their options, which could revive the discussion about helicopter money.

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