The dollar's weakness lately is becoming more pronounced.
The U.S. dollar index is at a two-year low after the Fed's meeting yesterday. It's gone from a spike over 103 back in the worst of the Covid market-panic days of March to nearly below 93 this week. But it could still fall substantially from here.
As Morgan Stanley's Jim Caron pointed out on Power Lunch yesterday, U.S. "real" yields are now at almost negative 1%. Think of it as the 10-year Treasury yield adjusted for inflation; most people just use the 10-year TIPS yield as a proxy, and it's currently at -0.95% (see below). It means as far as markets and investors are concerned, borrowing rates aren't just low right now, they're deeply negative.
The last time real rates were this low, Mr. Caron pointed out, was in the 2011-12 period when Europe's debt crisis was at a climax and the U.S. lost its AAA debt rating after government spending and borrowing surged to support the economy following the financial crisis. That also happens to be the last time that gold prices were this high.
Here's the thing: back in those days, the dollar was trading in the 75-80 range. If the dollar were to slump back towards those levels, how much more could the prices of gold, silver, stocks, and other assets rise?
I asked Mr. Caron why gold prices stalled out after 2012 while stock prices kept rising. The difference, he said, was the fiscal deficit. Back then, the Tea Party movement succeeded in capping and limiting government spending growth. The deficit narrowed from 7-8% to just over 2% of GDP by 2015. And the dollar has been above a floor of 80 or so since then.
But the deficit is widening out again sharply now and the government is still in spending-to-support-the-economy mode. The Tea Party, after all, took about four years to form after the last crisis, and we're likely facing a similar if not longer timeframe this time around. The deficit was already running 4.5% of GDP last year and will likely soar to 18% of GDP this year (!!) because of Covid-19.
Not a pretty picture, and it's why some (like Peter Schiff on the Joe Rogan podcast recently) are warning this will cause a major inflationary problem, and pointing to the jump in gold prices this year as evidence.
But...it would be a little weird if silver and gold were surging because inflation is coming at the same time bond yields are cratering because no inflation is coming. Markets don't usually work like that. In fact, gold prices are at record highs (5,000-year record highs, as Peter Boockvar likes to say) while government bond yields are at record lows on the shorter end and, soon, on the benchmark 10-year Treasury note.
This is a weak-dollar, reflationary paradigm, and given that GDP just fell by 33% annualized last quarter, we may in it for quite awhile--meaning stocks, bonds, gold, and silver can all keep rallying together while price inflation remains pretty muted. It ends in one of two ways; either higher inflation like Mr. Schiff is describing, which would immediately cap the rally in bonds and stocks; or gradual recovery and a turn towards fiscal tightening, which would cap the rally in gold.
We heard the same warnings last time around that the government response to the financial crisis would leave a legacy of higher inflation, only for that not to bear out precisely because voters pushed for fiscal restraint as a result. As precarious as the situation is this time around, we may well see a similar pattern play out. And if the push for fiscal restraint comes too soon and snuffs out the recovery, then I would expect gold, silver, and stock prices to struggle as a result.
We are at the first major inflection point now; surging fiscal deficits, sinking dollar, and rising asset prices. The second inflection point is still probably several years out.
See you at 1 p.m!