Has Gold Become the Risk-Free Rate?
Trades in Soda and Whisky;
I have had to raise the bar on my chart, as the US long-bond yield is up again and now sits at 5.3%, last seen in 2004.
US 30-Year Bond Yield
The bulls say this reflects growth, which is surging on the back of the AI capital expenditure boom. That is true, but it is also unsustainable. The bears say this is a debt crisis in the making.
Gilt yields are doing a noble job of keeping up with Treasuries, and it means the cost of borrowing will rise. Interest rates may or may not rise, as they are controlled by government-related agencies. But if they do not rise, inflation will surely pick up. What has never ceased to amaze me is how market expectations, manipulated or otherwise, have refused to acknowledge inflation as a future problem.
The 30-year inflation expectations, derived from TIPS prices compared to conventional bonds, barely ever move because they see inflation shocks as temporary and soon to pass. I think we’ll know a debt crisis has arrived because long-term expectations will finally start to rise, and maybe quickly.
US CPI Inflation (YoY) and US 30-Year Inflation Expectations
The first-ever 30-year inflation expectation, published in 1998, was 1.5%. We still have two years until we find out what 30 years looks like, but so far, inflation has been 2.6% over 28 years. This means TIPS have been underpriced compared to conventionals, and have hence significantly outperformed. Post 2020, inflation has averaged 4.1%, but the forecasts still are just 2.2%. It doesn’t stack up. Gold is likely telling the story that TIPS won’t.
We all know that to reduce debt, governments have to balance their budgets. There is seemingly no chance of that happening. Instead, they juice the economy with more money, hoping for growth. From their perspective, the AI capex boom has been a stroke of luck.
Major Government Deficits
The Risk-Free Rate
I was listening to The Master Investor Podcast, hosted by the excellent Wilfred Frost, who interviewed the macro guru Luke Gromen. Frost asked Gromen what the global risk-free rate was, now that US Treasury yields face greater liquidity and market risk. For the first time ever, Gromen fell quiet. After a pause, he stated that whatever the bond yields were, the risk-free rate would still be very low, as it starts to resemble gold.
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