Bullish for Gold: Spiking inflation could send real yields lower no matter what the Fed does

Nominal interest rates are rising, putting significant price pressure on gold and silver. However, with price inflation heating up, it’s possible the real rates could fall, a bullish setup for precious metals.

The rapid rise in oil prices juiced CPI to the highest level since May 2023. This increasing inflation pressure has turned market sentiment away from monetary easing toward tightening. The FedWatch Tool reflects a 50-50 chance of an interest rate hike by this fall.

This is the primary dynamic driving gold and silver prices lower. Because they are non-yielding assets, a higher interest rate environment is considered a negative for precious metals.

However, Wisdom Tree’s head of commodities and macroeconomic research, Nitesh Shah, said he thinks the markets might be getting ahead of themselves because they are not factoring in real interest rates. And he believes real rates could drop even as nominal rates rise due to a rapid increase in price inflation.

"There's a lot of potential for real rates to go down, especially if the Fed is holding still and inflation is rising."

What is the “real” interest rate?

In simplest terms, the real interest rate is the stated rate you see on the news, adjusted for price inflation. To calculate the real interest rate, you take the quoted nominal rate and subtract CPI. This tells you how much your investment will yield in real purchasing power over time.

For example, the 10-year Treasury bond is currently yielding just over 4.5 percent. That seems like a pretty good return. However, the CPI is running at 3.8 percent. That means the real interest rate on a 10-year Treasury is only 0.7 percent (4.5-3.8=0.7). 

That’s hardly a reason to spurn gold (or silver).

A catch-22

Shah hinted that the Federal Reserve is in a Catch-22. He pointed out that the Fed isn’t in a position to cut rates right now, even if the economy starts to show signs of cracking.

"Right now, the data doesn't really allow for rate cuts because inflation is rising. Cutting rates in this environment would be disastrous from a credibility standpoint."

However, there is a giant Debt Black Hole looming in the economy. Debt-riddled economies don’t function very well in a higher interest rate environment. That means the central bank’s ability to hike may be limited.

"Gold prices are as elevated as they are right now because markets are worried about the sustainability of debt," Shah said.

The debt situation isn’t going to change for the better any time soon.

And if the debt bubble pops, tipping the economy into a recession, that would create another bullish scenario for gold.

"If you do start seeing economic deceleration, that's another reason for gold prices to rally," Shah said. "Gold tends to do well in recessionary scenarios. It is a very strong defensive asset."

Not to mention the fact that the central bank would almost certainly cut rates in this scenario – inflation or no inflation.

Shah noted that if the Fed simply held rates at the current level, a rapid inflation spike would put downward pressure on real rates. And he said he thinks the markets are underestimating the potential for “inflation surprises” moving forward. In fact, he said he thinks inflation is becoming entrenched.

"I think we're stuck with high prices.”

He’s right.

Inflation is the plan. The central bank will have to continue leaning into loose monetary policy to accommodate the federal government’s borrowing and spending. Even with inflation heating up, the Fed is running quantitative easing operations to ease pressure on the Treasury market.

Shah said he thinks the correction in gold since the beginning of the year and the relentless downward price pressure are temporary.

"I think we're sitting on a bargain in gold right now."