Daily Commentary BY THE CURVE TEAM –

Sentiment Shift

20th of July, 2021

Markets are in the process of digesting contradicting news.

US treasury yields continued to decline overnight, falling around 10 basis points to 1.19%. This takes them to the lowest levels since early February, when there was a sharp run up in yields.

Earlier in the year, the beginning of the vaccination rollout and the prospect of huge stimulus payments meant the outlook for inflation was extremely buoyant. Indeed, those expectations have eventuated, with inflation in the US currently at 5.4% annually.

After reaching highs of 1.77% in March, 10-year treasury yields have since declined. Usually, such a strong run up in inflation would translate to higher yields at longer tenors, as high inflation decreases the real return of bonds.

However, concerns of the delta stream, which has covid case numbers surging even in highly vaccinated countries, has re-ignited concerns for growth. It has the potential to delay the re-opening of international borders and halt activity.

Further, the Fed has taken a more hawkish bent since earlier in the year. It has brought forward its guidance on when they expect interest rates to rise.

These factors, combined with ongoing QE and reverse repo programmes, have kept yields subdued despite the lofty inflation numbers. Many expected yields in Australia to gradually increase post TFF.

Recent declines show that firstly, that yields remain linked to overseas yields. Secondly, like in the US, excess liquidity does not instantly evaporate, it takes a lot of time to absorb and therefore translate to higher rates.

Finally, it shows the economy remains vulnerable while covid is around. Sustained outbreaks could very well delay central bank tightening, which would result in lower rates for longer than expected.

Josh Stewart

Associate - Money Markets