On April 6th, Federal Reserve "second in command" Governor Brainard indicated that the balance sheet could be reduced as early as May. The market began to speculate on the Federal Reserve's "sharp rate hike of 50 basis points" swiftly shifting to "rapid balance sheet reduction." This marks the first public statement from Brainard, who has been seen as dovish, since the Fed began raising interest rates for the first time in three years in March. Her sudden shift towards a hawkish stance immediately triggered a market response, causing a significant stir.
Inside the Federal Reserve headquarters' conference room
U.S. stocks plummeted across the board, with the Dow Jones Industrial Average falling by 0.80%; the S&P 500 Index dropped by 1.19%; and the Nasdaq Composite Index fell by 2.26%. This also led to the U.S. Dollar Index strengthening for the fourth consecutive day against a basket of other currencies, reaching a two-year high. The dollar's rise made oil more expensive for holders of other currencies.
International oil prices fell, with U.S. crude oil futures once dropping by more than 3%, breaking the 100 mark, and Brent crude also refreshed its daily low to $104.53 per barrel. This was influenced by the continuously rising dollar and growing concerns that the public health crisis might slow down crude oil demand. Additionally, the International Energy Agency (IEA) is expected to announce the release of oil reserves in the coming days, which many traders consider a fait accompli, providing additional momentum for oil prices to retreat.
The Federal Reserve's faster and earlier tightening of monetary policy also led to a continued expansion of losses in U.S. Treasuries, with Treasury yields rising to multi-year highs. The 10-year Treasury yield increased by 13.1 basis points to 2.543%, marking the largest single-day gain since March 2020. The two-year yield rose by 7.2 basis points to 2.500%. Meanwhile, the two-year to 10-year Treasury yield spread remained at approximately 3.97 basis points, continuing its inverted status. For most of the time since last week, this yield spread has been negative. Bond yields and prices are inversely proportional; a rise in yields indicates that net sales volume exceeds purchase volume.
This also led to a decline in gold prices, as the rise in U.S. Treasury yields and market expectations of further tightening of monetary policy by the Federal Reserve offset the safe-haven demand for gold that might be triggered by new sanctions against Russia. Spot gold closed at $1,923.76 per ounce, down from the previous day's close of $1,932.44. U.S. gold futures fell by 0.3% to $1,927.50.
However, history has shown that during the early stages of commodity inflation, changes in gold prices often lag behind those of other commodities, but eventually, gold outperforms them. Currently, under the influence of the Russia-Ukraine conflict driving inflation higher and supply chain issues, gold may play the role of a "catch-up" in 2022. Data indicates that in tail events related to significant regional conflict crises, gold often has a positive reaction. Although prices may fluctuate dramatically, they tend to remain high in the months following the event.
According to the latest report released by the World Gold Council on March 28th, gold plays a significant role as a safe haven during crises. Against the backdrop of the U.S. using the dollar as a tool for sanctions, which may deter some U.S. Treasury buyers, central banks globally are turning to diversify international reserve assets and reduce dependence on the dollar, using gold as a means of diversification and security. This has led to global official gold reserves reaching 35,536.8 tons, the highest level in nearly 30 years, indicating the significant role gold plays as a safe haven during crises.
It is widely believed that the two-year U.S. Treasury yield has the potential to break through 3%. According to the stress test model updated by the MSCI Risk Management team on April 6th, if U.S. inflation exceeds 10% in the next two months and the economy enters a recession (as indicated by the inversion of several U.S. Treasury yield curves that reflect the health of the economy), then the investment return rate of U.S. Treasuries may decline by 13% to around 5%.
In this regard, some economists' latest views, as cited by the U.S. Quartz website on April 3rd, suggest that although the Federal Reserve has begun to raise interest rates and there is a trend of acceleration, it still cannot turn the real yield of U.S. Treasuries into a positive data value (currently, the real yield of the 10-year U.S. Treasury is negative 5.39). With the real yield of U.S. Treasuries remaining in the negative range over the long term (after deducting inflation), this also means that the high inflation at a 41-year high has already hedged the interest costs of the United States. There is a possibility of implicit default in the U.S. bond market.This also makes it very likely that global central bank investors at the cornerstone level of U.S. debt, including Japan, China, the United Kingdom, Australia, Russia, Turkey, Germany, and others, will continue to significantly sell off U.S. debt in 2022. If the ongoing Russia-Ukraine conflict continues to increase pressure on U.S. inflation risks, there is a possibility of completely eliminating U.S. debt.
According to the report published by the World Gold Council on March 25, the future returns on bonds will become increasingly poor. If bonds increasingly and persistently exhibit a positive correlation with stocks, they may even lose their risk diversification and hedging capabilities. The low returns on bonds may limit their ability to respond to safe-haven events, and investors may also consider gold and cash as a viable hedging option.
The data from the World Gold Council's report also shows that for the 14 months ending in March, more than 60% of the total inflows into Asian gold ETFs came from the Chinese market. The total holdings of gold ETFs in China exceeded 80 tons, the highest on record. Additionally, over the past 12 months, China has significantly increased its gold imports. Customs data shows that in 2021, China imported a total of 818 tons of gold, more than 120 tons more than in 2020.
According to data cited on April 1, since 2012 when Switzerland began recording data, Switzerland has exported an average of about 600 tons of gold to China per year. According to a report published by the U.S. financial website ZeroHedge on April 2, citing customs reports from Switzerland and Dubai, gold exports to the Chinese market surged to the highest level since 2018 in the 14 months ending on March 18. The most recent batch, approximately 198 tons of gold, was shipped to China from Europe and America in March. These market statistics indicate that since 2021, at least 1016 tons of gold have been shipped to China in batches.