Yields on 30-year bonds and oil make new decade long highs dragging down gold

Thursday morning the release of the Producer Price Index for August showed that producers were paying more for raw materials, this usually is passed down to the consumer and tomorrow’s Consumer Price Index will show us to what extent that is happening. The PPI for August rose 0.4% month-on-month according to the Labor Department's Bureau of Labor Statistics. Annual producer inflation accelerated to 5.4%, exceeding market expectations of 5.3%.

The second more pronounced inflationary force was the huge spike in oil prices. WTI crude shot past the $100 mark having its strongest day since April 29th and advancing by $7.26 or 7.51%. The closing price is worthy of a closer look as it not only is the highest close of the entire conflict involving the Strait of Hormuz, but it is the highest closing price since 2014 at $103.93.

If we put a 4 hour candlestick chart of Light Crude Oil (Continuous) Futures (CL1!) above a chart of Gold Futures in the same format you can easily see how oil’s big gains today are identical (other than magnitude) to gold’s dramatic decrease.

This was the main cause of traders increasing their rate hike expectations for next week’s FOMC meeting. The odds according to the CME’s FedWatch tool jumped up by a full 10% on Thursday now giving a quarter percent rate hike a 70% chance of occurring.

Not only did oil hit levels not seen in over 10 years. 30 Year US Treasury yields rose to 5.366% their highest value since 2004.

With this in mind lets break down longer term treasuries and their relationship with the Fed Funds rate to determine what affect if any they will have on next weeks rate decision.

The Fed directly sets the overnight federal funds rate this heavily anchors short-term tools like 3-month Treasury bills. For longer-term debt instruments such as 10 and 30 year bonds the Fed’s influence is entirely indirect.

For those longer dated securities their moves are tied to the markets and future sentiment looking out 10 or 30 years from the time they are bought and are steered by three drivers;

Inflation Fears: Expected inflation erodes fixed-income purchasing power. If investors anticipate inflation rising, they demand higher long-term yields to compensate for that risk.

Economic Outlook: Strong economic growth shifts money out of safe-haven Treasuries and into riskier assets, dropping bond prices and pushing yields up.

Supply and Issuance: When the US Treasury floods the market with heavy new debt issuance, bond prices fall, which forces market yields higher to attract buyers.

It is the Supply factor that has recently shifted as the Treasury has begun to double its purchasing of long term bonds while giving room to increase the amount they purchase per day to increase even more.

Looking at a chart of the three major US Treasuries We can see that yields in all lengths of maturity have been rising sharply while the fed funds rate has remained flat. Usually they tend to move in the same direction so this divergence suggests further suggest an interest rate hike next week and that is what brought gold down sharply today.