Bonds a no-go: What rising inflation risk means for gold

Highlights

• January review: Gold’s impressive rally took it above the US$5,000 mark.
• Looking forward: US inflationary worries and the prospect of rising bond volatility could dominate gold’s behaviour going forward.

The 5k club

A staggering 14% rally in January took gold above the US$5,000 mark, cementing the 5k number as a headline to match the first recorded annual 5,000 tonnes of total demand. The month closed at US$4,982/oz and scored 12 all-time highs (Table 1). But it was not without drama with large intraday swings on the last two days of the month.

Our Gold Return Attribution Model (GRAM) showed an unusually large contribution from implied volatility (c.50% of January’s return), reflecting substantial option market activity. This variable currently sits in risk & uncertainty, although is likely more reflective here of momentum.

Global gold ETF flows provided plenty of support adding 120t in January to take holdings to a new record, valued at US$669bn. The flows were dominated by Asia (62t) and North America (43t) while Europe saw more modest inflows (13t).

 

Uphill struggle for bonds

Geopolitics has dominated the narrative and driven recent volatility, but this influence could fade, at least temporarily, shifting focus back to macro fundamentals. In the US, easier monetary policy and the fiscal boost appear geared towards running the economy hot, reviving inflation risks. Indeed, while the consensus view is that inflation will ease back to the subdued levels experienced prior to the pandemic, inflation risks could be greater than investors think.

Inflation risks

The case for a resurgence in inflation rests on several factors:

• A neutral rate likely higher than the Federal Open Market Committee currently estimates1
• The lagged tariff effects, as pre-tariff inventories are drawn down and pass-through to consumers emerges1
• Prospective fiscal support through possible renewed Affordable Care Act (ACA) subsidies and tariff ‘dividend checks’ ahead of mid-terms elections2
• A tighter labour market with the breakeven rate lower than assumed3
• Looser financial conditions than headline figures suggest, given low household debt servicing ratios, a lower need by large corporations to fund themselves via debt, and a sizeable private credit market4
• Rising household inflation expectations and limited spare capacity (Chart 2).

Market signals are mixed so far

The decline in implied rates volatility (MOVE) likely reflects a more benign near-term inflation narrative and reduced policy uncertainty.

But term premia remain high, consistent with investors still pricing meaningful medium-term inflation and supply risks – particularly against a backdrop of persistent budget deficits (Chart 3).

What it means for the stock-bond correlation

The stock–bond correlation typically turns more positive when the dominant shock is inflationary, supply-driven, or fiscally driven, as both asset classes can sell off together. Recent negative inflation surprises have helped pull the correlation back down (Chart 4).

Against this backdrop, we expect the bond-equity correlation to be unreliable other than if we were to see a serious downside market stress environment. A renewed inflation upswing would also put the incoming Fed leadership’s credibility to the test. Any hint of a more hands-off stance would likely support gold, via stronger inflation-hedging demand and a higher stock–bond correlation. By contrast, a clear turn towards policy hawkishness could curb gold demand in the near term.

In summary

The recent run-up in gold prices probably warrants a pause, but we see continued investment demand as a feature of 2026. Geopolitics is likely to remain the primary driver, with macro conditions potentially reinforcing the trend - most plausibly via a renewed rise in inflation expectations amid fiscal support ahead of the mid-term elections, pushing the stock–bond correlation higher.

Risks to gold stem mainly from elevated precious-metal prices themselves while a sustained easing in geopolitical tensions could also take some heat out of the rally.

With the new Fed leadership decided, markets will have to grapple with an incoming hawk likely having to do the bidding of a dovish administration. How that plays out will become clearer once Warsh starts to articulate the vision for his tenure. From what we know, that feels surprisingly like a continuation of the status quo, despite Trump’s sharp criticism of Powell’s strategy and at a time when the central bank is facing one of the most severe tests to its independence.

In our view, the new setup should continue to favour equities via strong growth and leave yields higher for longer. That said, a reduced balance sheet could be a headwind for risk assets and gold, as liquidity is reined in.