Bond sell-off deepens, as US yields reach key threshold

All eyes are on the bond market on Wednesday, after Tuesday’s global bond rout. There are signs that European yields are stabilizing, with only mild gains for the French and German 10 -year yield. The UK is an outlier, and its yields are climbing once more, albeit at a slower pace than Tuesday.

UK yields are rising in unison with US Treasury yields. The 30-year US Treasury yield is rising sharply on Wednesday and is higher by 4bps, it is testing the key psychological 5% level. This is considered a line in the sand: the US has a budget deficit of 6.33% of GDP, at 5% + levels for long term debt, this could trigger concerns about US fiscal sustainability, and it may also lead to further risk aversion.

Dollar at risk

Interestingly, the dollar has not come under serious pressure so far today. It has backed away from the highs of the morning, but it remains elevated. So far, the FX market is not walking to the same tune as the bond market. Back in April, when US Treasury yields surged, the dollar tanked. If we see a continued sell-off in US debt that causes higher yields, then we expect support for the dollar to wither.

As the market digests the second day of weakness in the global bond market, sentiment for global stocks is starting to fade. European indices are higher on the day, but have given back early gains, suggesting that a recovery after Tuesday’s sell-off looks premature. The futures market is still predicting a positive open for the S&P 500, but expectations have been scaled back. If we continue to see the sell off in bonds, then equities could find it hard to rally in this febrile environment.

The FTSE 100 looks vulnerable

If long dated bonds continue to fall, and yields continue to rise, this could be a problem for banking stocks. Banks have been a key driver of the FTSE 100 and the Eurostoxx index this year. Financials are the largest weighting in the FTSE 100, and the index is underperforming the rest of Europe so far this morning, as the financial and communication sectors act as a drag on the index.

Late November budget could spook the market

In the UK, the focus is likely to remain on the budget for some time. The Chancellor is expected to announce the date of the Autumn Budget later today. There are whispers that this will take place on 26^th November, which would be late in the year for a Budget to take place. However, while the bond market may take fright at this ‘delay’, since it could lead to further damaging speculation about tax rises, there could be a method to the madness. Reports late on Tuesday suggest that the Prime Minister is working to push through a raft of spending cuts, specifically on disability payments, which have ballooned since the pandemic. If the delay generates a well-rounded budget, that does not rely on growth-chilling tax rises to plug the UK’s fiscal hole, then this could be welcomed by the bond market and any sell off could be short lived.

However, UK bond yields have been on an upward trajectory for most of this year and have risen significantly since Labour took office. Thus, the bond market will need some hefty persuading that Labour will reign in public sector spending and bring the UK’s finances under control. This is why we expect to see bouts of UK bond market volatility in the coming months.

GBP vulnerable to further weakness

The pound is also in focus, after it sold off heavily on Tuesday. It was the worst performing currency in the G10 FX space and GBP/USD fell more than 1% to $1.3350. After the bond market domino falls, the currency market domino falls next. GBP/USD is lower again on Wednesday and we expect it will be hard to find support if the bond market sell off continues.

Gold continues its ascent

The gold price continues to extend gains into record territory on Wednesday and is comfortably trading above $3,530. The gold price is reacting to fears about stagflation: high inflation, lower interest rates in the US and sluggish growth. Thus, all eyes could be on the US JOLTS job openings report later today. A lower number, signaling a stronger labour market, could lead to a reduction in interest rate cut expectations which may weigh on the gold price, while a strong number could exacerbate stagflation concerns and boost the yellow metal. Overall, while the bond market remains volatile, we expect gold to remain in vogue.