Gold and U of M inflation expectations
May 18, 2020
Two and five year treasury yields ended the week near historic lows at 14.7 bps and 30.7 bps respectively. The ten year ended at 64 bps, just 10 higher than the all-time low of 54 set March 9, and the 30-yr at 133, having gotten just a shade below 1% in early March.
Zoltan Pozsar of Credit Suisse put out a note last week suggesting that libor-OIS could tighten to 10-20 bps by the end of June. Given a Fed Effective rate of 5 bps in the month of May, and a SOFR of 2 to 6 bps, EDM0 and EDU0 remain cheap given this potential tightening. EDM0 settled 99.675 or 32.5 bps and EDU0 at 99.715 or 28.5 bps. Pozsar’s prediction would put libor at 15 to 25 bps, a Eurodollar equivalent price of 99.75 to 99.85. Powell’s comments that the Fed was not considering negative rates likely makes 99.85 a soft cap for now.
These price levels have already been achieved by the reds. The peak contract on the curve is EDU’21, having settled Friday at 99.81. The all-time high this month is 99.825. This compares to the previous high set in December of 2012 at 99.63. At that time EFFR was 16 to 17, so libor-ois was around 20.
The high for gold in 2012 was $1790/oz. In September of 2011 it peaked at $1900. Interestingly, silver’s high in 2011 was nearly $50/oz compared to Friday at $16.61. The gold/silver ratio in late 2011 to 2012 was between 40 and 60. In March of this year it hit a high of 125 and is now 102. Gold is giving a glimmer of inflationary prospects or increasing financial stress or perhaps both, trading this morning at $1761 with silver at $17.30.
On Friday, the University of Michigan released its survey which includes long term inflationary expectations which surprisingly bounced to 2.6% from 2.5. The gap between the ten year yield and the 5-10 year inflation expectation is just over 195 bps, which appears to be a record. Obviously actual inflation has declined as oil prices plunged and other suddenly unneeded inventory was discounted. The question going forward is how this divergence will resolve. Higher prices which pull yields up, or dampened future expectations to justify today’s yields? The U of M survey suggests the former, but keep in mind this was a preliminary reading. In any case, extraordinary treasury supply necessitated by gaping budget holes should serve to keep yields from continuing lower.
Powell’s 60 Minutes interview aired last night, but excerpts on news sites indicate that he’s optimistic the economy will recover, though uncertain as to timing, saying it might stretch through the end of next year. However, he noted that his optimism assumed there is not a second wave of Corona in the fall.
| 5/8/2020 | 5/15/2020 | chg | ||
| UST 2Y | 14.9 | 14.7 | -0.2 | |
| UST 5Y | 32.3 | 30.7 | -1.6 | |
| UST 10Y | 67.8 | 63.8 | -4.0 | |
| UST 30Y | 138.2 | 131.4 | -6.8 | |
| GERM 2Y | -77.8 | -72.8 | 5.0 | |
| GERM 10Y | -53.7 | -53.1 | 0.6 | |
| JPN 30Y | 45.2 | 47.3 | 2.1 | |
| EURO$ M0/M1 | -14.5 | -13.0 | 1.5 | |
| EURO$ M1/M2 | 3.5 | 3.5 | 0.0 | |
| EUR | 109.71 | 108.17 | -1.54 | |
| CRUDE (active) | 26.17 | 29.52 | 3.35 | |
| SPX | 2929.80 | 2863.70 | -66.10 | -2.3% |
| VIX | 27.98 | 31.89 | 3.91 |
