After a week of mayhem across global markets, calmer tones are finally prevailing. The source of all the stress was the bond market, where yields started to break down. Such a move usually signals worries about weaker economic growth, which would ultimately translate into slower rate increases by central banks.
Is the bond market short squeeze done?
When the bond market says something might be wrong, other asset classes pay attention. Stock markets came under fire yesterday and commodity currencies got hammered, while safe havens like the yen and Swiss franc shined bright. It was a classic risk-off move, with concerns around the rampaging Delta variant being blamed as the catalyst.
However, that may be only half the story. The other part may be more technical in nature. Positioning in the bond market was stretched-short before this debacle, which means everyone was betting on higher yields by shorting the actual bonds. Fears around the Delta variant might have sparked the initial move, but it was likely amplified by a ferocious short squeeze in Treasuries.
What does it all mean? In a nutshell, this pandemonium could fade soon as the short squeeze runs its course. We are already seeing signs of that today, with Treasury yields rebounding and Wall Street stabilizing. If that is the case, the latest gains in the yen and franc could evaporate soon.
Dollar claws its way back, gold struggles
The US dollar declined yesterday but is on track to close the week higher overall. That is quite impressive considering that falling Treasury yields are usually the dollar’s kryptonite, and is a testament to the reserve currency’s safe-haven appeal. If the world economy - and especially emerging markets - are going to take a hit as the Delta variant spreads, then the dollar is probably the place to hide. The US is among the leaders in the global vaccination race and its economy will likely suffer the least thanks to the gargantuan spending programs.
The dollar is essentially an all-weather currency. It can shine both when markets are fearful and when optimism is riding high, amid expectations of US economic exceptionalism.
Over in commodities, gold could not advance yesterday even despite a softer dollar and falling real yields, which is a bad look. On the bright side, the precious metal is set to close the week with decent gains. Still, the big picture remains gloomy. It will be tough for bullion to regain its former glory if the havoc in bonds was truly a short squeeze that will fade out, and with inflation fears subsiding.
ECB minutes, Canadian jobs, and earnings
As for today, the spotlight will fall on the minutes of the latest ECB meeting and jobs numbers out of Canada. We already heard from the ECB yesterday when it raised its inflation target, so the minutes are unlikely to move the needle for the euro.
The Canadian data could bring some relief to the loonie, which has been demolished by the pullback in oil prices this week. Even so, vaccination rates are high and the outlook for the economy remains bright with US spending spilling over. The Bank of Canada could be among the first central banks to raise rates this cycle.
Finally, Wall Street is headed for a higher open today as the stabilization in the bond market has given investors the green light to buy another dip. The recovery’s mettle will be tested next week when US banks get the earnings season rolling.