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The message from low bond yields and gold bugs

Here are the leading questions for markets and investors as a new trading week beckons.

The rift between economic data and lower bond yields

Top tier government bond yields have steadily fallen from their recent peaks in July, and beyond the nuclear sabre-rattling between the US and North Korea, it appears fixed income investors are rather gloomy about things.

As the 10-year US Treasury note yield plumbs its lowest level since last November, near 2 per cent, so the relationship between short and long term maturities — a classic market barometer of recession risk — has flattened. It comes as soft data, such as the survey-based ISM manufacturing series, has been robust, while hard data, such as monthly jobs figures, suggest late-cycle hiring momentum and the notable absence of wage gains.

Luca Paolini, chief strategist at Pictet Asset Management, notes: “Either leading economic indicators are too optimistic or bond markets are too bearish. A divide has recently opened between the bullish future painted by current surveys and the economically bleaker one the fixed income market is discounting.”

He suggests: “Ultimately that gap will close, and bonds are going to take the hit.”

Others take the view that there is no disconnect between low yields and high-flying equities, given the supportive role played by central bank purchases of bonds, running at nearly $2tn so far this year alone.

But a closer look at the US equity market, loitering near record peaks, also shows a degree of angst. The strong outperformance of fast-growing companies, notably in the technology sector, says a lot about lacklustre expectations for the rest of the economy. Equity investors have also sought companies with strong balance sheets, another sign of a defensive mindset, and one that suggests the cheerleading of market bulls is misplaced. Absent fiscal stimulus, Wall Street looks vulnerable, particularly as the momentum of double-digit earnings growth is fading.

How far can you push the PBoC?

Watch carefully the Monday morning “fix” of the onshore renminbi market — where the People’s Bank of China sets the midpoint of the daily permitted trading range. The renminbi has jumped 4 per cent in six weeks to its highest in nearly two years. The pace of the rally is quickening too — which is making some uneasy given Beijing’s well-known dislike of market “volatility”. If the PBoC is unhappy, setting a weaker fix at 9.15am local time — 15 minutes before trading begins — is how it will send that message. If it doesn’t, then this rally could go far further, very quickly.

Gold’s glittering run set for a bump?

Gold bugs have a lot to like at the moment. The precious metal has appreciated some 17 per cent this year, with a gain of 7.5 per cent alone over the past month towards $1,360 an ounce.

A big driver remains the faltering dollar and moribund expectations of US inflation pressure picking up that should keep interest rates low. A temporary deal over the US debt ceiling, kicked down the road to December, also may encourage buyers of any dip in the gold price until political uncertainty fades.

Indeed, analysts at Goldman Sachs estimate that worries over North Korea have only been a modest factor in the yellow metal’s price rally. “We find that the events in Washington over the past two months play a far larger role in the recent gold rally followed by a weaker dollar.”

Ahead of US inflation data for September due out Thursday, some believe gold has room to continue rising.

Numis Securities says: “Gold has now broken out of the long-term down channel that it had traded in since 2012 and is now at the upper end of the short-term up channel that it has traded in since the beginning of the year. These are both good things.’’