Safe-haven assets have surged in July on fears the spreading Delta variant will derail the global economy’s recovery from the pandemic. The USD has pushed the EUR below 1.18. Gold is trading above USD1,800 and 10Y Treasury yields have sunk to as low as 1.12% this week before bouncing back towards around 1.30%.
As we wrote earlier this month, the decline in yields has been exacerbated by technical factors. Investors have been covering short positions in the bond markets, the US government has been issuing less Treasuries to finance its spending as the authorities instead have drawn down balances held at the Federal Reserve, and pension funds have been rebalancing portfolios by buying bonds. But short covering, changes in the US government’s bond sales and institutional investors’ reallocations are only likely to depress yields temporarily.
More fundamentally, yields have also declined as investors fear that global growth is peaking after its strong V-shaped rebound this year. At the same time, the spread of the Delta variant is already causing countries to impose harsh lockdowns across South East Asia, extend state of emergency measures in Japan and threaten new restrictions in Europe.
Financial markets fear economic activity may stall in Q3’21 but governments may not be willing or able to offer the same strong fiscal support as last year when the pandemic first emerged.
Source: Bank of Singapore, Bloomberg.
Thus, with bond yields highly volatile, investors are likely to follow economic indicators that track activity in a timely manner including monthly purchasing manager indices (PMI) to assess the impact of the Delta variant on firms’ confidence.
This week July’s PMI surveys will start being released from Friday. Currently, the indices are close to record levels in the US, UK and Eurozone. Any large declines in the PMI data will thus hit sentiment and push bond yields lower again. In contrast, if the surveys show firms’ confidence is holding up despite the Delta variant then demand for safe-haven assets is likely to ease and Treasury yields will rebound.
In the longer-term, we expect 10Y Treasury yields will return to a higher 1.50-2.00% range
First, we see vaccinations loosening the linkages between new infections on the one hand and hospitalizations and fatalities on the other. The UK’s decision to fully reopen this week despite the Delta variant surging across the country will provide an early test of resilience here.
Second, economic reopening will bolster risk assets again and reduce demand for safe-haven assets. In turn, central banks will feel more confident to start tapering quantitative easing, further reducing downward pressure on yields.
We thus maintain our 6- and 12-month forecasts for 10Y yields at 1.75% and 1.90% respectively.
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