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Will Risk-Off Trade Push Bond Markets Higher?

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Bond markets up amid trade war fears

The US bond market had a limited reaction to the Fed’s 25-basis-point rate hike and the 0.20% increase in interest paid on excess reserves. The yields, however, declined as investors observed a risk-off position ahead of the looming trade war between the United States and its trading partners.

The spread between the US two-year and ten-year bonds narrowed to 36 basis points, which led to a further flattening of the yield curve in the previous week. The Vanguard Total Bond Market ETF (BND), which tracks the performance of the bond markets, rose 0.06% for the week ended June 15 and closed at 78.92.

Bond market performance and speculator positions

For the week ended June 15, the ten-year yield (IEF) closed at ~2.9%, depreciating 2 basis points. The two-year yield (SHY) closed at ~2.6%, up 5 basis points, and the longer-term 30-year yield (TLT) closed at ~3%, down 5 basis points.

According to the latest COT (Commitment of Traders) report released on June 15 by the CFTC (Chicago Futures Trading Commission), speculator short positions on ten-year Treasury futures decreased last week. The total net bearish positions as of June 15 decreased by 61,552 contracts, from 397,546 to 335,994.

The week ahead for bond markets

Risk aversion is likely to be the key driver for bond market demand this week. Investors seem perturbed with the thought of an escalation of trade tensions, which could weigh on the demand for long-term bonds. An increase in demand could lead to a further flattening of the yield curve this week. Overall, the level of risk aversion is likely to be the key driver for the bond (BSV) markets this week.

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