Owen Thomas
It's exactly a year since gold suffered its biggest two day drop in thirty years. What's to stop it happening again?
Article / 12 November 2012 at 5:06 GMT

3 Numbers To Watch: Ahead of Cliff, 10yr Treasurys, gold, EURUSD

James Picerno James Picerno
editor/analyst /
United States

It's a sleepy day for economic releases, with the U.S. closed for a public holiday, but that provides an opportunity for reviewing the market implications of the Fiscal Cliff risk that looms over the U.S. economy in the days and weeks ahead. 

Three numbers to watch as that drama unspools will be the benchmark 10-year U.S. Treasury yield, the price of gold, and USD. Their levels will reveal quite a lot of real time intelligence about the market's perception of progress, or lack thereof, for resolving the fiscal cliff.

Today also marks the debut of yours truly—James Picerno—on this blog. Yes, there's a new editor in town, but the general focus on the "Three Numbers to Watch" for each days' trading, established by my predecessor, the estimable Yusuf Yassin, endures. One change that will be conspicuous, of course, is my own brand of analysis on each day's trio of critical numbers.

That leads to the obvious question: Who the heck is James Picerno? Take a look at my profile for an overview. Meantime, a short answer: I'm a veteran journalist and analyst with a deep appreciation and understanding of the nexus between markets and macro. You can't really understand one without the other, which has been—and remains—a guiding principle for this blog.

Fiscal Cliff may produce a new recession

With that in mind, let's take advantage of the slow news day and consider what promises (threatens?) to grab the headlines and drive the markets through the end of 2012: the fiscal cliff in the U.S. That's a reference to the automatic spending cuts and tax hikes that will kick in come January if Congress and President Obama don't craft a legislative solution in a timely manner. The fear is that political gridlock in Washington will prevail.

That's an all-too real possibility, and one that many economists predict will dramatically raise the odds of a new economic slump if the Beltway crowd doesn't get its act together. The Congressional Budget Office last week issued a report that echoes the views of many dismal scientists when it forecasts that "the significant tax increases and spending cuts that are due to occur in January will probably cause the economy to fall back into a recession next year."

If investors perceive that Washington's efforts at defusing this ticking time bomb are failing, there's a good chance that risky assets will take it on the chin as the year winds down. In that case, Treasuries are on the short list to become a safe haven all over again—at least until we see convincing signs that macro disaster will be averted.

Positives from a bond-holders' perspective

Do higher odds of falling off the fiscal cliff threaten the credit rating of Treasuries? No, since the fiscal cliff is all about sharp budget cuts and higher taxes. Those are positives from a bond holder's perspective because it boosts the lender's ability to refinance and pay off existing liabilities. But that rosy outlook is a short-term hazard for everyone else until further notice since it threatens economic growth in the short term.

As a proxy for which side's winning or losing, keep a sharp eye on the 10-year Treasury yield: if it's falling persistently from current levels, that's a signal that the crowd thinks the cliff is getting too close for comfort.


Higher demand for Treasuries implies a stronger dollar, of course, despite the dark news cycle for the U.S. that's been unleashed by fiscal-cliff worries. All the more so from a EURUSD perspective. ECB head Mario Draghi late last week warned that Germany is losing its immunity to various macro troubles that continue to churn across the rest of Europe. "The latest data suggest that these developments are now starting to affect the German economy," he advised. The U.S. macro outlook may not be much better, depending on the game in Washington, but Treasuries still retain a rather large relative edge over euro debt when it comes to paper-based ports in a storm.

In other words, the one-two punch of higher safe-haven demand for Treasuries and increased German vulnerability to the euro crisis could provide the right stuff for a dollar rally. Historically, a stronger U.S. dollar means a lesser price for gold, and vice versa. But this traditional negative correlation may temporarily give way in the waning trading days of 2012 if fiscal cliff troubles intensify.

Yes, the dollar and gold may rise together for a time. That's hardly the norm for the two markets. Then again, we're no longer living (or trading) in "normal" times.

The abnormal macro backdrop is likely to favor gold until the uncertainty on the fiscal cliff fades. Last month's profit-taking in the metal seems to have run its course. Short of a radical breakthrough on behalf of bipartisanship in Washington, gold looks poised to run higher while the pols squabble on in the land of divided government.

The latest sign that the budgetary chasm remains wide can be found in Republican Senator Mitch McConnell's post-election assertion that "I am not willing to raise taxes to turn off the sequester. Period." President Obama, basking in the glow of re-election, has a different view and says that the wealthy must pay more taxes to fill America's budget holes. "This was a central question during the election. It was debated over and over again. And on Tuesday night, we found out that the majority of Americans agree with my approach."

The gridlock game, in short, rolls on. It will be resolved... eventually, albeit with the details to be determined. Meantime, the prospects for gold—a store of wealth that's immune to fiscal follies and political spin—may be in the sweet spot to shine brighter.


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