The US yield curve is steepening following a dovish stance from Fed Chair Powell. The spread between the US 10-year and 2-year yields is now the widest since May, and the gap between the 30-year and 2-year yields is the largest since 2022. This reflects market anticipation of short-term rate cuts while long-term yields account for a premium due to inflation and growth concerns.<\/p>\n
The Fed is seemingly adopting a temporary stance reminiscent of its actions post-Covid rebound, yet the bond market appears sceptical. The steepened curve could suggest potential policy errors from the Fed, with prevailing conditions akin to stagflation risks over simply slowing inflation.<\/p>\n
With discussions of a rate cut in September, short-term yields are anticipated to decrease, while long-term yields may hold steady amid ongoing inflation expectations. Although not identical, this situation recalls the 1970s, suggesting a rising financial burden due to lasting inflationary pressures.<\/p>\n
In such a scenario, gold might greatly benefit, as its historical role as a hedge against inflation and currency volatility can reinforce the bullish case for the asset. The potential for gold to protect against economic fluctuations could become increasingly appealing.<\/p>\n
Given the widening gap between short and long-term yields, we should consider trades that profit from a continued steepening of the yield curve. A classic steepener trade involves buying 2-year Treasury note futures while simultaneously selling 10-year or 30-year bond futures. The spread between the 10-year and 2-year Treasury yields has already widened to over 55 basis points this week, a level we haven’t seen since the market volatility of early 2023.<\/p>\n
With the market now pricing in an 85% probability of a rate cut in September, we see an opportunity in short-term interest rate futures. Going long on contracts like SOFR futures that expire after the meeting could capture the expected drop in short-term yields. This move anticipates the Fed’s policy shift directly impacting the front end of the curve.<\/p>\n
The market\u2019s skepticism toward the Fed\u2019s narrative is understandable, especially after the latest core CPI reading came in at 3.1% year-over-year. This persistent inflation is why long-term yields are not falling with short-term yields, creating the steepening effect. We are essentially betting that the Fed is making a policy error, reminiscent of the early stages of the inflationary period we saw after 2021.<\/p>\n
This environment strongly supports a bullish view on gold as a hedge against potential stagflation. We have already seen gold test the $2,450 per ounce level, and there’s a noticeable uptick in call option volume on gold futures (GC) for December expiration. Buying call options on gold or gold-related ETFs offers a defined-risk way to profit from this uncertainty and the Fed’s challenging position.<\/p>\n
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