It’s all about bond yields

Right now, the investor focus is fixated on bond yields which continue to rise due to growing expectations that inflation will be returning as the global economic recovery is expected to speed up. The ongoing vaccine rollouts are starting to have an impact with new virus cases falling in a few places. The markets are pricing in a strong recovery once lockdowns end and things start to go back towards normal, as pent-up demand from households and businesses will likely replace government spending and central bank stimulus. As a result, investors have been moving out of bonds, causing their yields to rise. In the US, Treasury yields hovered around their highest level in a year, holding above that March 2020 high of 1.276% at the time of writing. If yields push onwards and upwards from here, then this could put some pressure on the stock markets.

But how much further will bond yields rise and how will this impact the wider financial markets?

So far, it has been gold which has absorbed much of the pressure from rising yields as this chart shows:
 

Source: ThinkMarkets and TradingView.com

But with the S&P largely ignoring the rising yields, things could unravel for US equities too if bonds continue to be sold.

The latest macro data released today underscored those expectations as US retail sales surged by the most in seven months, rising in January by a good 5.3% -- much better than 1.1% growth expected by analysts. The news lifted the dollar further and also weighed on US stock indices.

But are the markets right to think inflation is coming and the Fed will start normalising its balance sheet soon?

Well, it all depends on how the virus situation will evolve as well as the impact of the vaccines. My gut feel is that the markets are being far too optimistic about the prospect of the global recovery. So, I would think that the bond market sell-off is going to stabilise soon.

But for now, the weakness in bond prices have helped to lift yields across the major developed economies:


Source: ThinkMarkets and TradingView.com

What I want to see specifically for the US 10-year is whether the breakout above the March high will sustain itself. If we go back below the broken 1.276% level and hold there, then we could see renewed weakness for the dollar, and strength for gold.

Source: ThinkMarkets and TradingView.com