Bond market calm, but for how long?

There is a sense of calm in European and US markets. The recovery in global bond yields on Wednesday has helped sentiment,  the gold price is lower by $30 on Thursday and US and European stocks are pointing to a mildly higher open for European and US stocks later today, and a continuation of Wednesday’s rally.

Bond market recovery

There are signs that the bond market rout could be over. Global government bond sales have been strong this week and have not been impacted by bond market volatility. Added to this, some governments including the UK’s are talking once more about  public sector spending cuts, which may boost demand for Gilts in the short term.

Risks are still looming for the bond market, for example, Monday’s confidence vote in the French government. If the government collapses, then French bonds will be in the spotlight. Ahead today, there is a massive $11bn auction of French government debt. We will be watching this closely to gauge demand and to see if political turmoil impacts demand.

NFP looms large for markets

As we move through the week, the focus is on the US labour market. The dollar is stronger across the board on Thursday morning, even though Wednesday’s JOLTS jobs data pointed to a softening jobs market with fewer job openings and an increase in the layoff rate for July. This helped to calm the US Treasury market.  The Fed’s Beige Book also painted a weak picture of the US economy, which helped to put downward pressure on US yields, and push the 30-year US Treasury yield move away from the key 5% level.

The market is still convinced that there will be a Fed rate cut later this month, there is now a 97% chance of a rate cut on September 17^th. There is an 80% chance of a cut in December and a 53% chance of an October cut. Tomorrow’s NFP report will be crucial for interest rate expectations. If we get a reading above 100k, currently the market expects a reading of 75k, then we could see yields climb and rate cut expectations get pared back. Thus, today we could see little movement in yields as we wait for tomorrow’s key data.

UK yields fall, but risks remain

UK bonds were the top performer in Europe on Wednesday, and yields reversed Tuesday’s gains. The Gilt market brushed off some hawkish comments from BOE governor Andrew Bailey who sounded concerned about inflation and talked down the prospect of a rate cut in November. There is only an 18% chance of a cut in November, a month ago there was a 67% chance of a cut. Thus, UK yields may be able to reverse recent gains, but we still expect UK yields to remain higher than our peers’ yields for some time.

There is also talk that the UK’s neutral rate could be closer to 4%, which is historically high. This is not helping the pound, as the main driver of sterling is the UK’s fiscal outlook. With uncertainty likely as we lead up to the Budget in November, we believe that GBP/USD peaked in July at $1.38, and GBP may trade sideways below $1.35 in the short term.

Beijing puts the breaks on Chinese stocks

The contrast between US stocks and Chinese stocks is stark today. The CSI 300 is down 2%, after news that Chinese regulators were looking at measures to cool the stock market after a blistering rally since August.  Chinese officials want steadier returns and to promote ‘long term value’ not just short-term gains for speculators. The CSI 300 has risen by more than 7% in the past month, and there have ben big gains for Chinese tech firms, including Cambricon, the AI chip marker, which is higher by 75% in 4-weeks.

There was concern that Nvidia would not be able to capitalize on sales to China due to political risks, which fueled investor demand for Chinese tech stocks in recent weeks. Now that the Chinese government is trying to actively limit speculation and short-term gains, this could trigger some rotation out of Chinese stocks and that money is most likely going to end up in the US tech sector.

Google and Apple boost the Nasdaq

The Nasdaq was higher by more than 1% on Wednesday, after the index was boosted by large gains for Apple and Google. The search engine giant rose by more than 9%, after a US court ruling let Google keep its Chrome browser,  which means that the company will avoid major antitrust fines. Apple’s shares were also higher by more than 3% after it announced that it would launch AI powered web search for its Siri tool next year.

The enthusiasm for US tech stocks contrasted sharply with Chinese stocks, and Cambricon saw its share price tank 12% earlier today. This highlights how the Chinese stock market was propped up by tech enthusiasm rather than economic fundamentals, which leaves Chinese tech stocks vulnerable to further downside. We would expect the Golden Dragon index in the Nasdaq, which includes US-listed Chinese tech firms, to also lose some of its shine later today, and we could see investors rotate back to the ‘safety’ of US stocks now that the government is getting directly involved to limit upside in Chinese share prices.