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  • The rally in spot silver prices has continued on Thursday, with XAG/USD matching the November high and eclipsing $26.00.
  • Soft US data is has exacerbated expectations for more Fed easing, sent US yields lower and is supporting precious metals.

Spot silver (XAG/USD) prices are surging for a third straight day on Thursday, with prices briefly matching the early November highs just above the $26.00 level. XAG/USD currently trades with gains of more than 2.5% on the day and resides just above the $26.00 level.

Real yields plummet as soft US data exacerbates expectations for further Fed easing

Just released November US Housing data, which saw Building Permits rise to a record high 1.639M (its highest level in over a decade) and Housing Starts rise to 1.547M (nearly back to pre-pandemic levels around 1.6M) obscures weakness being seen elsewhere in the US economy. Indeed, most analysts would agree the ultra-low interest rate environment being championed by the Fed is behind the current housing boom, given how low rates make mortgages more affordable. Moreover, one might argue that the demographic of US citizens that can afford to purchase homes in the first place have been affected much less badly by the impact of the pandemic than those at the bottom of the income ladder, hence why by some metrics, the housing market is actually doing better than it was before the pandemic.

Either way, US economic weakness that is not showing up in the housing market was on full display in a much higher than expected initial jobless claims number for the week ending 12 December and in disappointing Philly Fed manufacturing numbers. Starting with the former, 885K Americans claimed unemployment insurance benefits last week, well above expectations for a rise to 800K, showing how badly the US labour market is suffering right now amid the increasing prevalence of Covid-19 in the country and tighter economic restrictions.

Meanwhile, the Philly Fed manufacturing index dropped from 44.3 in November to 11.1 in December, well below expectations for a drop to 20.0. The internals of the report were also ugly, with employment down to 8.5 from 27.2, New Orders down to 2.3 from 37.9 and Prices Paid down to 27.1 from 38.9.

The bad data combo triggered a rally in US bond markets, likely on anticipation that such bad data will spur the Fed into action in January. Indeed, Fed Chair Jerome Powell was keen to emphasise in the post-Fed meeting press conference on Thursday that the Fed has the flexibility to do more if needed and if economic conditions warrant further action. Bond markets thus appear to be betting on more QE in January, or at least a tweak to the bank’s current composition of purchases to include more longer duration bonds.

As a result, yields have dropped; nominal US 10-year yields have fallen back below 0.90% and 10-year TIPS yields (the real yield on the US 10-year) plummeted to lows below -1.06%, its lowest level since 3 September. Note that falling real yields makes non-yielding assets such as precious metals seem like a comparatively better investment, so when real yields drop this props up the likes of silver.

Markets bet that Fed action will spur inflation

More interestingly, Thursday’s poor economic data (Philly Fed and jobless claims data, anyway) did not prompt a drop in inflation expectations. In fact, the opposite occurred; prior to the data, 10-year breakeven inflation expectations were just under 1.91% and after the data they had jumped above 1.92%. This implies that rather than the market seeing near-term economic weakness as a detriment to inflation expectations over the coming 10-years, markets instead see bad data as increasing the likelihood that the Fed will jump in with further stimulus (likely in January), which will end up increasing long-run inflationary pressures.

Remember that precious metals such as gold and silver are seen as a hedge against inflation, so if markets are betting that bad data is going to spur the Fed into actions that will increase inflation, this ought to support precious metals.