How To Trade When Bond Yields & Equities Diverge?

Some investors say the bond markets usually know best, but if in doubt, stay out.
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how to trade when bond yields and equities diverge
Giles Coghlan
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Bond Yields & Equities Diverge

I just had a question from Sergei and Albert in the comment section, and Sergei was asking, “why are we seeing bond yields falling?” The risk appears to be on this, we’ll also deal with your question as well Albert.

Now, this is a anomaly that we see from time to time. Now just taking a look at the equity space we can see here on the right hand side that the equity markets are generally higher, we’ve seen strength in the commodity currencies, aussie, New Zealand dollar, Canadian dollar, weakness in the Japanese yen, Swiss franc and weakness in the US dollar.

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So it would appear that risk is on however, there’s a couple of things we’ve gotta factor in, look at the bond yields, now bond yields are now going against the equity markets. So usually, when we have a risk on market, we would say equity markets in the green and we’d also see bond yields here in the green. But we see the bond yields are in the red, indicating a divergence between the equity market and the bond market.

Now, this happened at the start of the year, equity markets were going higher and higher, but the bond prices were also going higher, which were yields were going lower so that was a dichotomy and eventually, the bond market was seemed to be correct. So there’s a general saying that, ” when the bond market and the equity market are in disagreement, go to the bond markets.”

The bond market for me is a bit of a tale here, sort of saying that it’s not getting carried away with this rise in the equity market. Now, why is the equity market been rallying? Now, there hasn’t really been any particular reason for risk on sentiment that we’ve been seeing in the last few sessions.

The general reason for the risk on sentiment is that there’s lots of extra money from governments all over the world who are wanting to boost their coffers and really help their cut back country and company with support programmes. So that’s been some of the reason for the recovery and equity markets that we’ve seen.

Although this is a, you know, I would argue this is a short term recovery, but we’ve seen upside in equity markets is the point I’m trying to make. However, see, the tricky thing is COVID-19 factors still remain, the big picture is it’ll be a risk off environment, that’s the most likely outlook.

So the equity market is being supported on the hopes of massive support programme. So this means this has been quite tricky to trade today. So today’s a positive sentiment, I say positive sentiment in inverted commas because I haven’t changed the bias to a full risk on because I’m not convinced that we are in a full risk on situation. Yeah, and the bond yields going different directions.

The equity market is one of the tales. And it was this comment from Angela Merkel, which really boosted The euro, when she said, let me just find it when she said, “there’s no indication, the response device must be huge.” So there was an uptick in the equity markets on that comment. And the hope is that, well, that’s going to be fantastic news for the Euro. But you’ll see, we’ve seen some of that initial enthusiasm just beginning to fade now, because What does it mean to be huge, and what Germany considers huge, may not be what Italy considers huge.

So it’s a little bit a little bit vague, it’s certainly not clear. So that’s why we maintained through the session, our euro US dollar, downward bias, and you can see we’re getting some strength in the dollar index. Now, the reason for that dollar weakness was that positive risk on sentiment, but that positive risk on sentiment wasn’t a full risk on sentiment.

So what’s tricky now? The rest of them is mixed. That’s what’s been making being quite confusing and difficult to trade today and the market is in that kind of, you know, torn between the different stories. So we’re sort of getting caught up a little bit in there in that story, but I can of course look out for any comments from the EU summit.

Any indication there is some more resources bigger package than expected, anything that’s more optimistic will be supportive for the equity markets. And then we’d like to see some more dollar downside, but for now, we maintain the status quo but as I said I’m keeping a very careful eye on things here. And we’ll update you when there is a definite change in risk sentiment, but as it stands, our euro US dollar and pound US dollar downside bias remain for the session.

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