Correction in risk assets apparently took a break on Tuesday, however weakness in oil and greenback strength persist. After a brief respite early in the session, greenback went on the offensive against major peers, commodity currencies, nonetheless it failed to develop conclusive advantage against emerging markets currencies complex. This is important positive signal suggesting that broad-based flight from risk hasn’t started yet. GBP and NZD led declines against USD, which at the time writing were down 0.60% and 0.55%.

The rally of long-dated Treasury bonds is probably the biggest warning signal that calls for caution. On Tuesday we saw another leg of growth despite major gains on Monday and last week, which could indicate some major shift in sentiment. 10-year bond yield plummeted to 1.14% on Tuesday to the lowest level since February 2021. When demand for long-term bonds rises, investors either expect inflation to ease or start to price out policy tightening from a central bank (or have a mix of these expectations). One way or another, both expectations are likely driven by worsening economic growth prospects.

One of the leading indicators of anxiety/optimism is the spread between yields on 10-year and 2-year US Treasury bonds. When it rises, markets are more likely to expect expansion and vice versa. Since May 2021, this indicator paints a worrying picture:

Markets are being swept by a new wave of concerns over the new Covid-19 delta strain. Despite progress in vaccination, the incidence is growing rapidly in parts of Asia and Europe. The threat of new restrictions boosts risk aversion, given the recent powerful rally which sent parts of the market to very elevated levels, risks are shifted towards continuation of risk-off.

The emerging "inconsistencies" in the story of global recovery have been reflected in the odds of early tightening of the Fed's policy. Expectations are shifting in favor of the fact that at the upcoming event in Jackson Hole, as well as at the September meeting of the FOMC, there will be no signals about early start of QE tapering (decline in the rate of Treasury and MBS purchases). In line with Fed Chief Powell's position that employment gaps justify continued monetary stimulus, the move to rate hikes could be delayed until 2022. Until the Fed sheds lighter on this matter, uncertainty related to the next Fed move will be a factor of pressure on risk assets.

The markets are now experiencing their fourth correction this year. The average size of retracement is 4-5%, the current correction is about 3.5% from the highs, that is, nothing critical yet.