The gold market is sharply higher Friday as a key recession gauge hit a 40-year high. Investors are reacting to the news that the yield on two-year notes has overtaken the yield of 10-year notes by 50 basis points. This is the most significant yield curve inversion since the 1980s, the last time the Federal Reserve was this aggressive with interest rates. Gold is higher by more than 2% on the day as the inverted yield curve and bargain hunting fuel the upside.
An inverted yield curve has always preceded a recession, and there is no reason to think that this time will be any different. With recession odds at 40-year highs, gold could stand to see more follow through buying in the weeks ahead. Although investors still expect the Fed to continue on its inflation fighting path, raising rates through 2023, that projection could change quickly if the threat of recession turns into reality. The Fed could very well find itself singing a different tune in early 2023 if the economy does tip into a full-blown recession. Not only could rate hikes stop, but the central bank could also even decide to start easing rates and taking them lower again.
The Fed has stated it wants to get inflation back to its desired target of 2% annually. This goal seems quite far-fetched at this point, however, as inflation remains near 40-year highs despite the Fed having hiked rates aggressively over the last year. The Fed could discover, sooner rather than later, that its objective is unattainable. Once the Fed realizes this fact, it may take an increasingly dovish approach to monetary policy and could start to take rates down again.
Also adding to some bullish sentiment this week was a recent report from the World Gold Council. The report stated that central bank buying of gold in the third quarter hit a record. Central banks bought nearly 400 tons of gold in Q3 for the biggest buying quarter on record. There could be numerous reasons for this increased central bank demand, including worries over the dollar, the war in Ukraine, the threat of a Chinese invasion of Taiwan and fears of a global recession. Whatever the case may be, if the largest financial institutions on the planet are buying gold, perhaps you should consider buying gold as well.
The market remains range-bound. The $1600 and $1700 levels are the key technical areas that must be breached for an extended move. The market has remained in between these levels for weeks now, and there is nothing to stop it from remaining in between them for an extended period of time. Once gld does breach these levels, on a closing basis, it could signal the beginning stages of an extended run that could take gold back to all-time highs or down to $1500. Central banks appear to feel odds may be greater for upside than downside. Either way, the long-term bullish thesis for gold remains fully intact.