Few would have thought real yields would have fallen below zero as the Fed hiked and gold shifted above $1300/oz at the start of 2016.
This seems to have little to do with the near term direction of the Fed Funds rate. Global forces appear to have played a big role, with the collapse in yields since Brexit proving to be persistent despite the initial impact on economic activity being fairly minor. But the the continued overestimation of growth and inflation prospects as well as the "natural" level of the Fed funds rate has likely had a large impact as well.
The fall in yields has also been accompanied by a weaker US dollar as measured by the broad trade weighted index (TWI). Much of this though has been centered on emerging market currencies and the Yen, with its surge an unintended consequence of the BoJs negative interest rate policy.
But a somewhat weaker US dollar doesn't appear to be as important to gold's gains as falling yields.
Debating the likelihood of a Fed funds rate hike over the remainder probably misses the bigger picture for what will drive gold and longer term real yields.
The bigger issue appears to be the lack of inflation despite the signs of a tightening labour market. One stark sign of this issue is the persistent erosion of long term inflation expectations over the past 5 years. As the chart below shows, breakeven inflation rates on 5 and 10 year TIPS have persistently declined since the financial crisis. Weak inflation expectations tend to create weak inflation outcomes.
CPI ex food and energy has drifted a little above 2% and with a strong dollar/falling commodity starting to fall out of the equation headline inflation should pick up too.
But PCE inflation, the Fed's preferred measure, remains stuck around 1.6%. It will probably take a meaningful period of comfortably above 2% underlying inflation before inflation expectations move back towards where they were just a few years ago. That will probably undermine gold and bond prices, although that point doesn't appear imminent.
