Investment banks weigh in the decline of long-term bond yields – Market Overview

Investment banks weigh in the decline of  long-term bond yields  – Market Overview

Should we expect more erratic market movements with no fundamental base?

We are approaching the closing date for Q1 2021, typically occurring before the Easter holidays. Around this time, investment and pension funds usually make their final adjustment to balance their portfolios, adding the decrease in liquidity typical for the holidays season. According to some investment banks, this is one reason why long-term bond yields have declined in recent days.

Banks like JP Morgan point out that pension funds are taking advantage of higher bond interest rates to add more bonds to their portfolios. However, this practice might not continue once the portfolio adjustment process is over. The bank mentioned above and others such as Deutsche, Bank of America or Societé Generale anticipates the U.S. 10-year bond yield to increase around 2%. The bond is currently trading around 1.62%.

At the moment, the Federal Reserve does not show any concern about bond yields, as the markets saw after President Powell and Secretary of the Treasury Yellen appeared before the North American Congress. Long term deterioration of financial conditions is a secondary concern for U.S. monetary policymakers. Their focus sits on the economic recovery process and inflation rebound (up to their 2% target). These two objectives would offer a real-world interest rate of 0% per purchasing power estimates.

This market dynamic does not look very favorable for stock markets. They have lost their previous bullish momentum and are moving sideways around their recent highs with no bullish continuity.

The U.S. Dollar started a downward movement, which was considered a change in trend after the Federal Reserve decided to lower interest rates in March last year, and long-term bond yields fell to minimum levels.

With the Federal Reserve determined to maintain this policy as long as necessary (at least until the end of 2023), the market assumed that the Dollar weakness would remain structural. However, the unexpected change in the interest rate curve has changed the market sentiment, and the U.S. currency is reversing towards an uptrend, ending the previous downward process.

We can see this in the graph of the DollarIndex.

The index has broken up a reversal pattern in this daily chart, having previously broken above the 100-day SMA line. Today it is trading above the Fibonacci retracement level of 0.618%. This movement could anticipate a change in the Dollar trend that would be confirmed breaches past level found between 94.30 and 94.60.

This upward movement of the Dollar has already been reflected in the price of the USD/JPY, the pair that has the highest correlation with the Dollar's long-term interest rates.

The pair has already reversed much of the previous bearish movement that began last March and headed towards a resistance zone located around 109.90. Such a breakthrough could provide further upward momentum to the pair.

Sources: Investing.com, Bloomberg.

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