Silvers slumps as Democratic Senate sweep sends US bond yields higher

Spot silver prices (XAG/USD) have been choppy on Wednesday, surging to highs in the $27.90s during the European morning (gains of up to 1.4% on the day at the time), before slumping back to $27.30s, where spot prices now trade with losses of nearly 1.0% or close to 30 cents on the day.

The precious metal has seemingly traded as a function of swings in sentiment towards the US dollar; when XAG/USD hit highs in the European morning, the Dollar Index (DXY) was at fresh multi-year lows in the 89.20s, but XAG/USD has since come off as the DXY has recovered back to highs of the day in the 89.60s.

Democrats sweep Georgia, initial market reaction

The main talking point in the market this morning was the fact that the Democrats managed to pull off a surprise sweep of the two available Senate seats in Tuesday’s Georgia election, handing them a majority in the Senate to go with their majority in the House, meaning the party will now have control over Congress. (Note: Democrats now have 50 seats to the Republicans 50, meaning Vice President-elect Kamala Harris will have the tie-breaking vote).

Whilst USD’s mixed reaction implies that the market remains undecided as to then long-term impact on the currency of more Democrat fiscal stimulus, the rise in nominal and real US bond yields appears to have weighed on precious metals markets, which are down across the board on Wednesday; US 10-year yields rose above 1.0% for the first time since February and the 10-year TIPS yield rose as high as -1.0% at one point. Higher bond yields tend to reduce the incentive to hold precious metals instead of bonds, hence some of the weakness being seen today.

Long-term reaction

Whilst the initial market reaction in precious metals markets seems to have focused on higher nominal and real bond yields, the longer-term implications of a Democrat-controlled Congress remain up for debate.

Precious metal bears might argue that recent developments will shape up to be a long-term negative given that higher US government borrowing will 1) continue to push nominal and real US bond yields higher, 2) foster a faster economic recovery in 2021 that will reduce demand for safe havens (like silver and gold) and 3) result in a less dovish Fed how that the government is doing more of the “heavy lifting” regarding fostering the post-Covid-19 economic recovery. Moreover, bears might argue that a faster US recovery as a result of higher government spending will be a long-term positive for USD that will weigh on USD negatively correlated assets such as precious metals.

Bulls might counter these arguments by saying that while nominal US bond yields might rise as a result of higher borrowing, real yields are likely to remain close to recent lows given 1) the fact that expectations for stimulus is pushing up inflation expectations (indeed, 10-year break-evens rose as high as 2.05% on Wednesday, up from the low 1.9%s at the end of 2020) and 2) expectations that the Fed will maintain easy monetary policy for at least the next two years. Indeed, the 10-year TIPS yield quickly reversed most of its rally back to -1.0% and now trades around -1.06%. If both of these factors do keep real yields low, this ought to support precious metals, which thrived in 2020 when US real yields plummeted below 0.0%.

Regarding the argument that a faster US economic recovery in 2021 (as a result of higher fiscal stimulus) would be negative for precious metals and a positive for the US dollar, would it? The faster recovery in 2021 will be powered not by real economic growth, but by larger US government deficit spending (a potential USD negative), which will undoubtedly bring about even larger trade deficits (another big potential USD negative). If a faster but debt-financed US recovery in 2021 does end up being a negative for USD, this is likely to be a positive for the likes of silver and gold.

Returning to the already noted rise in inflation expectations; if break-evens continue to rally, this in itself is likely to be a precious metal positive given the status of silver and gold as inflation hedges and long-term stores of value. For many analysts, a Democrat sweep to a Senate majority is unlikely to change their bull thesis.

For other, it might even strengthen it; a Democrat-controlled Congress means more fiscal largesse, which means more pressure on the Fed to maintain accommodative monetary conditions in order to ensure the solvency of the government, which means greater long-term inflationary pressures. All sounds pretty bullish in the long-term for the likes of silver!