Gold continues its rally

Last night, as widely expected, the French government collapsed after losing a confidence vote. The lower house’s unusual coalition of far-left and far-right deputies rejected the government’s plan to rein in France’s ballooning budget deficit. In his response, the outgoing PM François Bayrou warned: “you can change the government but you can’t change the reality” of rising and more expensive debt. Indeed, France’s 10-year yield, which dipped into negative territory before the pandemic, was trading near 3.6% last week before easing. The spread over German Bunds widened past the 80bp before narrowing again.

The French political deadlock looks set to continue, with both Marine Le Pen and Jean-Luc Mélenchon likely to oppose any successor government. After all, this is the third government change in a year and the fifth PM in less than two years. The question is why French bonds performed relatively well over the past sessions despite the looming collapse. Most likely, the risks were already priced in, and/or investors are betting that France will find a way to finance its deficit before the year-end deadline. Still, as the UK learned under Liz Truss’s mini-budget fiasco, market confidence can evaporate overnight. Today, UK 10-year gilts yield above 4.5% and with unappetizing outlook, leaving little fiscal headroom for Keir Starmer’s government, forcing policy adjustments through higher taxes or lower spending. France could face a similar fate if investors lose faith.

But for now, the market impact seems limited. The Stoxx 600 rose 0.5% yesterday, with the CAC 40 also higher, helped by expectations of lower Fed rates on horizon. European futures point to some downside pressure this morning, but the upbeat sentiment in the euro this morning suggests that the French news are not a big deal - it’s already baked into the market prices. The EURUSD is about to retest the 1.18 psychological resistance and with the French no confidence vote out of the way – with no surprise – the pair could clear resistance and look at the next hurdle: the 1.20 mark.

In the US, investors took weak jobs data as confirmation that the Federal Reserve (Fed) is preparing to cut rates at its next three meetings, with some betting on a 50bp move as early as September. The S&P 500 on Monday consolidated just below record highs, while the 2-year yield fell to its lowest in a year. Still, this week’s inflation data could reinforce or derail those bets. JPMorgan analysts warn of a potential “sell-the-news” reaction to Fed’s upcoming rate cuts and recommend hedging with gold and VIX futures.

Meanwhile Gold continues its rally, supported by central bank buying and demand from investors seeking alternatives to Treasuries. For those who still love Treasuries, softer US yields reduce the opportunity cost of holding gold, reinforcing the golden momentum. The metal is technically overbought, but Goldman Sachs recently noted that if just 1% of privately held Treasuries were reallocated into gold, the price could approach $5,000/oz. Too high? Remember that one Bitcoin is worth more than $111K this morning.

In energy, US crude rebounded yesterday and is extending gains, even after OPEC signaled higher output over the weekend. Many analysts doubt OPEC will engage in a price war: US shale production generally struggles below $60–65/bbl, and several OPEC members are already pumping near maximum capacity. That suggests support for prices in the $60–62pb range, reinforced by a weaker dollar and persistent geopolitical risks, including the no-peace scenario in Ukraine in the near future.