The logic behind the surge in gold, is the U.S. debt not recognizing it?

Despite gold prices soaring to $4,000, the dollar exchange rate falling, and stocks hitting new highs, discussions in the market about "devaluation trades" are rampant. However, the U.S. bond market, which should be most sensitive to inflation risks, remains unusually calm, with its core long-term inflation expectation indicator still firmly anchored around the Federal Reserve's 2% target.

The so-called "devaluation trade" is based on the core logic that investors bet the government will "dilute" its increasingly large debt burden by creating inflation. Under this expectation, hard assets such as stocks and gold, which can hedge against inflation risks, are naturally in high demand.

Analysis suggests that currently, gold and U.S. Treasuries are telling two completely opposite grand stories. The logic of gold represents a "vote of no confidence" in future monetary credit: it bets that the U.S.'s massive debt can ultimately only be diluted through inflation; while the logic of U.S. Treasuries is precisely the opposite, representing a "vote of confidence" in policy credibility: its stable long-term inflation expectations show that the market believes the Federal Reserve will successfully defend its inflation target, or that an economic slowdown will naturally suppress prices.

From the data perspective, current U.S. macro data is also full of contradictions: a slowdown in employment provides a basis for the Federal Reserve's "preemptive rate cuts," while strong growth and signs of rising inflation have led others to worry that rate cuts could fuel future inflation.

Therefore, the core game in the current market revolves around betting on which economic signal will ultimately dominate the Federal Reserve's decision-making—whether to choose rate cuts to respond to potential recession or to be forced to tighten policy to suppress inflation. This is not only a divergence point in the pricing logic of gold and U.S. Treasuries but will also determine the ultimate direction of major asset classes in the short term.

"Devaluation Trade" Frenzy, Gold Soars

In the past 12 months, gold prices have surged by 51%, breaking through the $4,000 mark. During the same period, the dollar's exchange rate against a basket of major currencies has fallen by more than 10%. Meanwhile, as an asset that can hedge against inflation risks, the stock market has also repeatedly hit new highs.

This series of market performances has led more and more investors to discuss "devaluation trades."

The so-called "devaluation trade" is based on the core logic that investors bet the government will "dilute" its increasingly large debt burden by creating inflation. Under this expectation, hard assets such as stocks and gold, which can hedge against inflation risks, are naturally in high demand.

The real basis for this logic is that under the current backdrop of high government debt in major global economies, inflation, as a hidden tax, can indeed effectively reduce debt. Taking Japan as an example, the country has successfully reduced its net debt-to-GDP ratio from a peak of 162% in 2020 to 134% this year through inflation while continuing to run deficit spending.

In contrast, although the U.S. has also experienced inflation, due to larger government spending, its net debt-to-GDP ratio has risen from 96% in 2020 to 98% this year. This kind of financial situation, where one eats into future resources, naturally raises market concerns about resolving debt issues through money printing in the future In addition to concerns about the fiscal outlook, there are several strong driving forces behind the rise in gold: First, global central bank reserve managers, especially those looking to reduce dependence on the "unpredictable United States," are continuously increasing their gold reserves for asset diversification; second, in an environment of declining interest rates, the appeal of gold as a non-yielding asset naturally rises; finally, the sustained price increase itself has attracted a large number of trend-chasing momentum buyers.

Bond Market "Watching Coldly": Is Out-of-Control Inflation a False Proposition?

However, the hot narrative in the gold market does not seem to be recognized in the more professional and larger bond market.

Data shows that the key indicator measuring market expectations for long-term inflation in the future—the "five-year, five-year forward breakeven inflation rate"—has remained stable and close to the Federal Reserve's 2% target level, without fluctuations due to the surge in gold prices.

This indicates that professional bond investors do not believe that uncontrollable hyperinflation will occur in the future.

Not only in the United States, but the European inflation swap market also shows that investors have confidence in the European Central Bank's ability to control inflation. Even in the face of fiscal difficulties in France, the market has not priced in a scenario that would require large-scale inflation to rescue.

Behind Market Divergence

If it is not due to a common inflation expectation, what then causes the same or divergent price movements of different assets?

A more reasonable explanation is that different markets are driven by different logics, leading to a divided perspective in the entire investment community.

The rise in the stock market may stem more from a fervent bet on the technological revolution of artificial intelligence (AI) and optimistic sentiment about the U.S. economy achieving a "strong growth, moderate inflation" ideal combination driven by AI investment, rather than simply inflation hedging.

The logic behind the rise in gold is more complex. As mentioned earlier, in addition to some investors considering risk hedging, there are also factors such as central banks of various countries, low interest rates, and momentum buyers.

Media analysis suggests that this market division is rooted in fundamental disagreements about the outlook for the U.S. economy. Current macro data is itself full of contradictions: on one hand, signs of a slowdown in the job market have led some to worry about the economic outlook and believe that the Federal Reserve's preemptive rate cuts are reasonable. On the other hand, economic growth data remains strong, and inflation has shown signs of rising, which makes others worry that rate cuts could fuel future inflation.

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

In the long run, if the United States does not change its fiscal trajectory, a "debt market showdown" triggered by debt will eventually come, at which point inflation is likely to become the easiest choice for politicians, but that day seems far off.

In the short term, the fate of the market is in the hands of the Federal Reserve. If economic growth continues and the slowdown in employment is merely a false alarm, the Federal Reserve will have to abandon rate cut expectations and even return to the rate hike path. At that time, the party for stocks, bonds, and gold will come to an abrupt end. Only when the Federal Reserve chooses or is forced to tolerate an overheating economy and allows the flames of inflation to burn can the logic of "devaluation trades" truly be realized