Bonds, Precious Metals Markets Converge on Inflation Concerns

Figure 1: Precious metals prices soared until late January before correcting

Figure 2: Bond yields fell until late February before beginning to rise

What caused the sentiment in these two markets to converge? And where might they be headed next?

Fed Chair Kevin Warsh and the Central Bank Independence Narrative

The run-up in precious metals prices appeared to have been based on three market narratives:

1. Central bank independence might be eroding.
2. Central banks cutting rates in 2024 and 2025 despite above-target inflation in most countries/currencies.
3. Expansionary fiscal policy and large budget deficits in the U.S. and elsewhere.

In late January, the news of Kevin Warsh's nomination to head the Federal Reserve (Fed) seemed to raise concerns that the Fed was at risk of losing its independence. In 2011, Warsh resigned from the Federal Open Market Committee (FOMC) and began voicing his opposition to Quantitative Easing and holding rates near zero for extended periods. He didn't seem like a policy maker intent on keeping the money printing press running. Indeed, in chairing his inaugural FOMC meeting in mid-June, Warsh's Fed officially removed its easing bias.

Over the past five months, precious metals prices have fallen sharply, although they remain well above early 2025 levels, suggesting that while inflation concerns have abated, they remain present. Over the past few months, investors in Fed funds futures and SOFR futures have gone from pricing 50 basis points (bps) of rate cuts over the next two years to 50 bps of rate hikes. Gold prices usually move inversely with rate expectations, rising in 2019 to mid-2020, and 2023 to early 2026 when rate expectations fell, and trading sideways when sentiment shifted to higher rates (Figure 3).

Figure 3: Gold prices are inversely correlated to Fed policy-rate expectations

A Turning Point for Interest Rate Policy Globally?

Paradoxically, rising core inflation probably helped to pull precious metals prices lower. While precious metals are traditionally viewed as inflation hedges, accelerating inflation is sometimes unwelcome news because it tends to push up short-term interest rate expectations.

Indeed, rising rate expectations in the U.S. correlated with rising core inflation. Over the past few months, core PCE has risen from 2.8% YoY to 3.3%.

While the Fed has removed its easing bias and Fed fund futures are pricing the likelihood of rate hikes, other central banks have already tightened policy (Figure 4). Thus far in 2026, the Bank of Japan, the European Central Bank, the Reserve Bank of Australia and Norges Bank of Norway have raised rates (Figure 5). And, the forward yield curves in many other nations are signaling the possibility of higher rates. The main driver appears to be that core inflation has been persistently running above target for years in the majority of these countries (Figure 6).

Figure 4: Some central banks have already begun tightening policy

Figure 5: Futures markets price higher rates in Canada, Japan, U.K. and the U.S.

Figure 6: Core inflation remains above-target in most countries outside of China

Budget Deficits

While central banks are beginning to tighten monetary policy, fiscal policy remains extraordinarily loose. Up until 2017, the U.S. budget deficit averaged about two percentage points less than the unemployment rate as a share of the economy. That is, if the U.S. had a 5% unemployment rate, the budget deficit was probably around 3% of GDP. Since 2017, however, this structural dynamic has flipped: the deficit has transitioned from being roughly unemployment minus two percentage points to unemployment plus two percentage points. Despite a relatively low unemployment rate of 4.3% currently, the U.S. is running a budget deficit of between 5% to 6% of GDP.

The U.S. is not an exception in this. Nations as diverse as Brazil, China, France, Germany, Japan, and the U.K. are also running large fiscal deficits. In Brazil and China, deficits are at 7.7% and 8.2% of GDP, respectively-surpassing the 5.8% for the U.S. as projected by the Congressional Budget Office in the current fiscal year ending September 30. France and the U.K. have deficits of 4.9% and 3.9% of GDP, respectively. Deficits are currently smaller in Germany and Japan (3.8% and 2.0% of GDP, respectively), but both nations plan to ramp up public spending later this decade on infrastructure and defense. Japan's public debt is close to 200% of GDP, roughly double that of its major peers. A similar deficit expansion holds true for the nations within the Gulf Cooperation Council in the Middle East.

While budget deficits do not drive the precious metals and bond markets on a day-to-day basis, they carry significant consequences from year to year. The persistence of these structurally large deficits risks producing two outcomes:

• A massive volume of debt issuance that could drive sovereign bond yields significantly higher.
• Structural concerns over the long-term sustainability of public finances could drive investors into precious metals.

While U.S. bond yields have not risen significantly in response to these concerns, they have elsewhere. Japanese government bond yields have been soaring (Figure 7). Bond yields in France, Germany, the U.K., Australia and Canada have also been rising sharply, especially for longer maturities (see appendix charts 1-5).

Figure 7: Japanese bond yields are soaring, could add to fiscal pressures

U.S. Treasury yields have not been rising as much as their foreign peers so far in recent months as the U.S. Treasury has increased its issuance of T-Bills while the Federal Reserve has curtailed its quantitative tightening, reducing the amount of long-term debt coming into the market (Figure 8).

Figure 8: U.S. Treasury has sharply curtailed issuance of long-term debt

While favoring T-bills over long-term bonds suppresses long-term yields in the short term, an increased supply of T-bills heightens the concentration of highly liquid assets of the private sector. Because these instruments function quite similarly as cash, this supply shift could act as a backdoor means of monetary easing.

Looking Ahead

Are precious metals at bargain prices after their recent decline, or will they continue to sell off? Will bond yields continue to rise or are they near a cyclical top?

In the short-to-intermediate term, any increase in central bank rates is likely to push short-term rates higher and precious metals prices lower. As such, any continued rise in core inflation might be bad news for investors in bonds and precious metals.

Longer-term, the direction of budget deficits could play a determining role in the outlook for precious metals and long-term bond yields. Any coordinated political effort to rein in deficits could lower long-term yields and reduce the structural lure of precious metals. Conversely, the persistence or further expansion of these deficits could likely push long-term yields higher. At present, there appears to be very little political impetus anywhere in the world to implement tighter fiscal policy.

Finally, the equity market remains a wild card. So long as equities continue to go higher, economic growth is likely to be sustained, increasing the likelihood of resource shortages that keep core inflation rates above central bank targets. Consequently, a prolonged equity bull market may remain fundamentally bearish for both government bonds and precious metals.

However, if the equity market undergoes a severe correction, economic growth could slow sharply-particularly in the U.S., where the public is heavily invested in stocks. This could oblige central banks to reverse course and lower rates, potentially setting the stage for a renewed bull market in precious metals.

Appendix Charts

All examples in this report are hypothetical interpretations of situations and are used for explanation purposes only. The views in this report reflect solely those of the author and not necessarily those of CME Group or its affiliated institutions. This report and the information herein should not be considered investment advice or the results of actual market experience.