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Covid wobble punctures calm markets. Get used to it

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What to make of the latest market wobble? If you blinked and missed it, you are in good company. But to recap, Monday was a bit of a horror show.

In its worst trading day of the year, the pan-regional Euro Stoxx 600 index fell 2.3 per cent. The US picked up the baton, sending the S&P 500 sinking by a similar degree before regaining a little poise towards the end of the day.

Oil prices took a 7 per cent hit, only part of which could be explained away by the Opec cartel and its allies nearing a deal to raise output.

Bonds shot higher. Yields on the 10-year benchmark note dropped under 1.18 per cent for the first time since February, down more than 0.1 percentage points on the day. Perhaps most notably, though, the pain for the reflationistas did not stop there; the following day also brought sharp gains in the market’s premier haven asset, cramming yields under 1.13 per cent.

The picture was clear: this was a classic outbreak of nerves puncturing a seemingly relentlessly cheerful, if rather dull, market mood. Finding a satisfying explanation, however, is more tricky.

After-the-fact rationalisation number one is that investors finally woke up to the Delta variant of coronavirus. This makes some instinctive sense: in 2020, it took weeks of devastation in Asia from the initial outbreak of Covid-19 for western investors to take it seriously. It was not until northern Italy shut down in late February of that year that investors ran for safety in earnest. This could be a rerun.

Taking that argument further, some suggest that the bond market — a magnet in times of crisis — somehow understands the grim potential economic impact of Delta better than investors in the stock market, hence the more significant and lasting effect there.

True, bond investors tend to have a keener eye on potential doom and disaster than their equity market peers. They can smell central bank stimulus from a mile away. But this explanation does not really stack up. Equity investors read the newspapers, too. Genuine shifts in market sentiment, from benign and boring to worried and wobbly do not tend to unwind completely within two days, as this episode did.

By the middle of the week, not only had bonds backed down again, but stocks were also marching higher. 

The potential impact of Delta has been a known risk to investors for weeks. Its public-health implications are clearly a concern, and businesses are suffering with the so-called “pingdemic” of workers instructed by apps to isolate. But bluntly, Delta matters to markets only to the extent that it might push major economies back in to strict, economically punishing lockdowns. Right now, that seems politically toxic.

“We’re as worried as everyone else about the Delta variant,” wrote Oliver Brennan, senior macro strategist at TS Lombard in a note this week. “But, objectively, our investment case is unswayed by the current virus wave: the link between cases and hospitalisations in this wave is weak. Don’t let your heart rule your head.” 

One senior bond-trading banker in London thinks he has the answer to what is really going on here. “Well, it is August,” he told me this week. I will spare him the blushes of identifying him; though it has been very hot in the UK, and the past 18 months have felt long, it is of course still July. 

Calendar confusion aside, his point is that markets are in holiday mode. It is quiet, moves are generally small and slow, many traders and investors desperate for a change of scene have hit the beach. Such sleepy summer days are, in any year, often characterised by abrupt, seemingly random shocks in the associated poor trading conditions.

“You often see these flights to quality, particularly during the summer,” says Mark Dowding, chief investment officer at BlueBay Asset Management. “A lot of the flow is down to the machines and the models and you are left scratching your head. You can have days like Monday when it looks like the sky is falling in, then you have other days when it’s all Goldilocks.”

Bond investors and traders agree that “their” market is somewhat skittish at the moment, just as it was in the opposite direction in February. Then, yields shot higher alarmingly quickly in a rush among asset managers to dump bonds in preparation for higher growth and inflation. Now yields are demonstrating the same clunky, stop-start illiquidity on the way down. “The Fed has said ‘we’re watching the data’ so it’s not giving very clear leadership,” says Dowding. That leaves the bond market a little unmoored, he adds.

Summertime silly season is not a new phenomenon. Nor, sadly, is the Delta variant of coronavirus. But both are likely to combine to create further slip-ups in the coming weeks and months.

Kasper Elmgreen, head of equities at Amundi, says markets are starting to worry about what is “on the other side” of Covid pandemic after a very strong reflation trade. “You can be double vaxxed and still get this. That was not the narrative last year. It’s less black and white,” he says.

Brace for bumps in the road, he says. “This is not a straight line. This was never going to be a straight line.”

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