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Reading signals in the dollar and gold markets

JUL. 28, 2020

Chart showing ICE US dollar index, July 2010 to July 2020

Investors have fixated on the equity and fixed income markets this year, as stock valuations approached record highs and bond yields hovered near record lows. But more recently, their focus has turned to the foreign exchange and precious metals markets, trying to interpret the signals that the U.S. dollar and gold prices are sending.

As recently as March, the U.S. dollar index spiked to its highest level in 17 years as investors rushed to safety at the outset of the coronavirus pandemic. Since then, the dollar has lost nearly 8% of its value. (See chart above.) Throughout much of Asia and Europe, coronavirus cases peaked earlier, so these economies are further along in their recovery efforts. In addition, the Federal Reserve’s balance sheet and the federal budget deficit have exploded, perhaps giving global investors pause when considering how to allocate to dollar assets. A strong dollar dampens inflation and keeps interest rates low, so a weaker greenback would have the opposite effect, putting upward pressure on import prices and yields.

In precious metals markets, gold prices hit an all-time high on Monday, July 27, topping $1,944 per ounce. (See chart below.) Gold is generally viewed as an inflation hedge and the recent record high suggests investors are more worried about possible inflation brought on by the enormous expansion by the Fed and government spending. The implied inflation rate embedded in 5-year TIPS has risen from 0.1% in March to 1.4% today. This remains extremely low by historic standards, but the rapid shift is notable.

chart showing New York gold prices, July 2010 to July 2020

The equity market embeds substantial optimism on the direction of the economic recovery, while the bond market implies cautious optimism on a sustainable recovery. Investors should watch the commodity and foreign exchange markets, however, as they tell a different story on confidence in the domestic economy and the government’s actions. This disconnect is unusual and may pave the way for a pullback in either equity prices, bonds or gold prices.

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