The logic behind gold's surge: U.S. Treasuries aren't buying it?

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Despite gold prices soaring to $4,000, a declining dollar exchange rate, and record highs in stocks—with talk of “devaluation trades” rampant in the market—the U.S. bond market, which should be most sensitive to inflation risks, remains unusually calm. Its core long-term inflation expectation indicators remain stably anchored near the Federal Reserve’s 2% target.

The so-called “devaluation trade” is essentially based on investors betting that the government will “dilute” its ever-mounting debt burden by creating inflation. Under this expectation, stocks and hard assets like gold that can hedge against inflation risks naturally become favored.

Analysts believe that currently, gold and U.S. Treasuries are telling two completely opposite grand narratives. Gold’s logic is a “vote of no confidence” in the future of monetary credit: it bets that America’s massive debt will ultimately have no solution but to be diluted by inflation. The logic behind U.S. Treasuries is exactly the opposite—a “vote of confidence” in policy credibility: its stable long-term inflation expectations show that the market believes the Fed will successfully defend its inflation target, or that economic slowing will naturally suppress prices.

Looking at the data, current U.S. macro figures are also full of contradictions: a slowing job market provides grounds for the Fed’s “preemptive rate cuts”, while strong growth and signs of rising inflation make others worry that lowering rates will fuel inflation down the line.

Thus, the core market game now is betting on which economic signal will ultimately dictate the Federal Reserve’s decisions—whether to cut rates to counter potential recession, or be forced to tighten policy to contain inflation. This is not only where the divergence in pricing logic between gold and U.S. Treasuries lies, but will also determine the trajectory of major asset classes in the short term.

“Devaluation Trade” Frenzy, Gold Soars

In the past 12 months, gold has surged 51%, breaking the $4,000 mark. Over the same period, the dollar’s exchange rate against a basket of major currencies has dropped by more than 10%. Meanwhile, as assets that can hedge inflation, stocks have repeatedly hit new highs.

This string of market performances has prompted more and more investors to talk about “devaluation trades.”

The so-called “devaluation trade” is essentially based on investors betting that the government will “dilute” its ever-expanding debt burden by creating inflation. Under this expectation, hard assets like stocks and gold that can hedge against inflation risks naturally become popular.

The real-world basis for this logic is that, against the backdrop of high government debt in the world’s major economies, inflation, as a form of “invisible tax,” can indeed effectively reduce debt. Take Japan, for example. Through inflation and ongoing deficit spending, it succeeded in lowering its net debt-to-GDP ratio from a 2020 high of 162% to 134% this year.

By comparison, although the U.S. has also experienced inflation, its higher government spending means its net debt-to-GDP ratio actually rose from 96% in 2020 to 98% this year. Such fiscal “robbing Peter to pay Paul” naturally raises market concerns about solving the debt problem by printing money in the future.

Beyond concerns over fiscal prospects, several powerful forces have driven gold higher: first, global central bank reserve managers—especially those wishing to reduce reliance on an “unpredictable America”—have continued to increase gold reserves for diversification; secondly, in a falling-rate environment, gold’s attractiveness as a non-interest-bearing asset naturally rises; finally, the persistent upward trend in price naturally attracts a large number of momentum-driven buyers.

Bond Market “Watching Coldly”: Is Runaway Inflation a False Threat?

However, the heated narrative in the gold market seems to find little recognition in the much larger and more professional bond market.

Data show that key indicators for the market’s long-term inflation expectations—the “5-year, 5-year forward breakeven inflation rate”—have remained stable and close to the Fed’s 2% target, showing no volatility despite the surge in gold.

This suggests that professional bond investors do not expect runaway, uncontrolled inflation in the future.

This is not only the case in the U.S.; Europe’s inflation swap markets also show investors’ confidence in the ECB’s ability to control inflation. Even with France’s fiscal troubles, the market has not priced in a scenario needing massive inflation to rescue the situation.

The Split Behind the Markets

If it’s not due to shared inflation expectations, what then is driving the synchronized or divergent moves in different asset prices?

A more reasonable explanation is that different markets are being driven by different logics, and the investment community is split in its outlooks.

The stock market’s rise is likely more the result of fervent bets on the artificial intelligence (AI) revolution, and optimism that the U.S. economy can achieve the ideal combination of “robust growth and moderate inflation” powered by AI investments, rather than a simple inflation hedge.

The logic behind gold’s surge is even more complex. As mentioned, beyond some investors hedging risk, factors include central banks, low interest rates, and momentum buyers.

Media analysis argues that this market division is rooted in fundamental disagreements about America’s economic future. Current macro data itself is full of contradictions: On the one hand, signs of a weakening job market have some worried about the economic outlook and see preemptive Fed rate cuts as justified. On the other hand, economic growth data remains strong, and there are signs of inflation picking up, leading others to fear that rate cuts could stoke inflation in the future.

Ultimately, investors need to clearly distinguish between long-term risks and short-term realities.

In the long run, if the U.S. does not change its fiscal trajectory, a “bond market showdown” caused by debt will eventually arrive. By then, inflation is likely to be politicians’ easiest solution, but that day still seems far off.

In the short run, the market’s fate lies in the hands of the Federal Reserve. If economic growth persists and the job market slowdown is a false alarm, the Fed will have to abandon expectations of rate cuts—possibly even resume hikes. At that point, the party for stocks, bonds, and gold alike will come to an abrupt end. Only if the Fed chooses—or is forced—to tolerate an overheated economy and allow inflation to burn, will the logic of the “devaluation trade” truly be fulfilled.

Risk Warning and DisclaimerMarkets have risks, investments require caution. This article does not constitute individual investment advice and does not take into account individual users’ specific investment objectives, financial situation or needs. Users should consider whether any opinions, views or conclusions in this article are suitable for their particular situation. Investing based on this is at your own risk. ```