Why weak investor sentiment is putting pressure on bond yields

The emergence of the Covid-19 Delta-plus strain has cast doubts on global growth outlook expectations

US equities have had particularly notable gains in June and July, with all three major indexes trading near record levels. AFP

Markets have kicked off July where they left off in June – continuing their upward movement. The gains have been notable particularly in US equities, with all three major indexes trading near record levels.

The move has been particularly curious amid a combination of US dollar strength through June and early July and the emergence of the Covid-19 Delta-plus variant, which is seemingly starting to cast doubts on global growth outlook expectations once again.

Covid-19 cases peaked at 35,000 new cases a day in the UK – the highest since January – and earlier this month, Japan took an aggressive stance towards the surge in coronavirus cases by banning all spectators from the coming Olympics.

This was followed by a US Federal Reserve member stating that one of the biggest risks to global growth may be celebrating a premature victory over Covid-19.

Deteriorating global sentiment as a result of this new Covid-19 variant is perhaps what is mounting pressure on bond yields and these lower yields are, in turn, fuelling equity markets. After hitting a low of 1.25 per cent on July 8, the 10-year Treasury yield is still currently holding below 1.4 per cent.

Despite posting a stellar four months at the start of the year when yields near doubled, the momentum seems to have been curbed.

While the recent move to 1.25 per cent last week may have been overstated, bond yields may continue to trade under pressure as the Fed continues to maintain its extended dovish stance towards future tapering, as stated in the minutes of its latest meeting. This is expected to be reinforced later on Tuesday as Fed chairman Jerome Powell testifies before Congress. Markets expect him to extend the Fed’s dovish stance.

Weakening US yields have come at a time where we are seeing dollar strength. This breakdown in the relationship between the 10-year yield and the greenback will be interesting to monitor.

Bond yields may continue to trade under pressure as the Fed continues to maintain its extended dovish stance towards future tapers

Gaurav Kashyap

While these two asset classes were previously correlated, we have seen a clear break in this trend since early June. The US Dollar Index has come through a bit of buying renaissance in June but I feel the rally may have run out of steam.

Technically, I am watching for 91.90 levels as an initial support level for the US Dollar Index, after which strong support kicks in the channel between 91.30 and 91.40.

This dollar strength is why the EUR/USD moved below $1.19 levels in June on the Dubai Gold and Commodities Exchange while GBP/USD futures traded below $1.39 levels on the DGCX.

While I expect trading to remain largely range bound through the summer months, I expect the former to stay below $1.20 levels through to August, while the pound should also stay below $1.40 levels against the US dollar until the end of July.

Gold continues to witness volatility. The DGCX gold futures contracts moved back above $1,800 in July after shedding more than 7 per cent in June. The precious metal has been on a roll since, closing seven out of the nine trading sessions higher.

Fundamentally, not much has changed for the precious metal and I see this more as a combination of dollar weakness and a technical correction.

At the time of writing, we are trading at a critical juncture, with gold at $1,806 levels. It is trading at the 200-day exponential moving average. The 50-day EMA seems to converge with the 100-day EMA at $1,813 levels.

This is something to watch for in the next few trading sessions. A conclusive break by the 50-day EMA through the 100-day EMA will technically put pressure on gold in the short term.

Finally, the earnings season kicks off in the US this week, with the big financial institutions announcing their results. Looking ahead to the rest of the month, after the Bank of Canada’s rate decision on Tuesday we await the European Central Bank’s rate review on July 22, followed by the all-important Fed meeting on July 28.

Gaurav Kashyap is head of futures at EGM Futures. The views and opinions expressed in this article are those of the author and do not reflect the views of EGM Futures