Opinion
Odd response: Why did US bond yields rise after the Fed’s interest rate cut?
Summary
- Yields on US sovereign debt should’ve fallen, but have risen since the central bank’s monetary easing. Various factors explain it—like a stronger than expected US economy, excess bond supply from a potential Trump victory and weaker foreign appetite for US Treasuries—but which factor matters most?
You wouldn’t normally expect market yields to surge higher at a time when the US Federal Reserve recently increased the size of its interest rate cuts from 25 basis points to 50 basis points. Yet, this is exactly what has happened.
Astonishingly, the yield of the 10-year US government bond has risen by more than 60 basis points from its level on 18 September, the day of the last Fed policy meeting. And the increase in yields has occurred right across all the major maturities.
While most analysts agree on the list of potential contributors to this unusual development, there is little consensus on their relative importance.
This matters for what we forecast about the future well-being of the US economy and for the sustainability of this year’s impressive stock market performance. Fortunately, the next eight days are set to bring clarity to a rather confusing situation.
Also read: Red-hot bond market powers wave of risky borrowing
Let’s start our review with the run-up to the last Fed policy announcement which, itself, was rather unusual. The widely held expectation that the Fed would cut by a quarter point was upended by what was seen as two heavily Fed-influenced articles indicating that a half-point reduction was a more likely outcome.
The fact that this ‘leak’ took place during the Fed’s ‘blackout period’ added to what already was an odd situation. And, sure enough, in what Bloomberg Surveillance anchor Jonathan Ferro called “Powell’s Draghi moment," the Fed announced a 50 basis-point move shortly thereafter.
Rather than welcome this cut as indicative of a more dovish policy posture, markets have taken yields higher right across the yield curve: At the time of writing, to 4.14% for the 2-year bond, 4.30% for the 10- year and 4.55% for the 30-year. Some analysts are even suggesting that the 10-year bond could spike further to above 5%.
Four main reasons are commonly cited for the change in the configuration of yields that have a significant impact on many other countries:
One, a series of data surprises that suggests that the US economy is stronger than what was the consensus forecast.
Two, a move in political ‘betting markets’ favouring not just former President Donald Trump’s chances at the election, but also a red sweep that could push the door wide open for the imposition of significant trade tariffs.
Three, the policy back-tracking that has become apparent in signals from Fed officials after 18 September, including in the Fed minutes released in mid-October.
Four, indications of weaker buying interest overseas in US treasury bonds.
Also read: US Treasury Yields soar: Fed caution, US Presidential Elections uncertainty among key reasons; Analysts expect reversal
While most agree on this set of potential contributors, all of which push traders to a higher terminal rate for the Fed and a slower journey there, there is little agreement on their relative weights. This matters for economic and market prospects.
Economic well-being would be well served by continued US growth and investment exceptionalism, especially at a time when China and Europe are struggling.
By bolstering corporate earnings, this would also help sustain the impressive stock market gains that include a 22% return for the S&P so far in 2024.
Indications of another round of flip-flopping in Fed forward policy guidance would, judging from recent history, either be neutral or somewhat negative. Much would depend on the extent to which it adds to general uncertainty and amplifies both economic and market volatility.
An erosion in foreign buying of US government bonds would come at a time when the other once-reliable purchaser, the Fed, is reducing its holdings rather than adding to them.
It would coincide with high bond issuance associated with 6% of GDP plus budget deficits in the US that shows no sign of serious moderation, together with significant government and corporate refinancing needs.
Quite a few economists worry that the potentially most troublesome possibility for the economy and markets would be a sudden surge in trade tariffs that is not accompanied by measures that compensate for its immediate inflationary impact.
Also read: Bond Traders Hedge Deeper Selloff, Targeting US 10-Year Yield at 4.5%
Should such tariff hikes materialize—a big if—they could push up prices that particularly hit lower income households already suffering from the exhaustion of their pandemic savings and an increase in credit card balances and other debt burdens.
The next eight days will provide analysts with a lot more information to assess the relative importance of these factors, both individually and collectively.
They will be paying special attention to the monthly US jobs report and JOLTs data, a host of corporate earnings, the outcome of the White House election and the next Fed policy meeting. Judging from market indicators, few are willing to bet big on any particular configuration—for now. ©bloomberg
