Bond market crash sheds light on inflation fears and stagnation expectations

Bond market crash sheds light on inflation fears and stagnation expectations

US Treasury yields rose on Friday, extending one of the biggest declines in the fixed income market in seven decades, as investors grapple with the twin fears of rising inflation and debt-fueled attempts to revive economic growth.

Yields on the benchmark two-year Treasury, which traded at 26 basis points in September last year, were held at 4.195% – the highest level since late 2007 – in early New York trade on Friday as traders reset the Federal Reserve’s interest rate hike bets. After a series of hawkish comments from Chairman Jerome Powell earlier this week.

This puts the 10-year Treasury yield gap, last seen at 3.754%, at about 44 basis points, a deeper “reversal” of the yield curve that often indicates a recession.

According to a study by the Federal Reserve Board of San Francisco, the sustained inverted yield curve has preceded all nine recessions that the US economy has experienced since 1955, making it a very accurate gauge of financial market sentiment.

In fact, US Treasury yields have risen more than 110 basis points since August 1, as noted by Bank of America in its weekly “Flow Show” report on Friday, helping to set global bond markets on pace for their biggest annual declines in more than seven years. contracts. .

What Bank of America calls a “bond meltdown” could “threaten credit events and liquidate the world’s busiest deals: buying the US dollar, buying US technology, long private equity.”

“The real surrender is when investors sell what they love and own,” Bank of America said.

The Federal Reserve’s seemingly unique hope of avoiding a so-called “hard landing” from its battle for inflation – a resilient labor market – is also beginning to waver. Weekly jobless claims missed analyst expectations for nine straight weeks, rising to 213,000 for the period ending September 17.

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The Fed itself sees the unemployment rate rising to 4.4% by the end of next year, a move it hopes will cool wage growth and prevent inflation from becoming more pervasive in the US economy.

Fixed income traders are also betting another 75 basis point rate hike from the Fed in November, according to CME Group’s FedWatch, while the Atlanta Fed’s Now GDP forecast tool indicates third-quarter growth slows to 0.3%. Just.

β€œIt’s possible that the unemployment rate could rise gently higher and wages could fall without an outright recession β€” but that hasn’t happened before,” said Bill Adams, chief economist at Bank of Comerica in Dallas.

β€œHistorically, increases in the unemployment rate of the size the Federal Reserve wants to see have coincided with a recession, which means significant declines in employment, income, production and sales, spread widely throughout the economy and may have lasted for more than a few months,” he added.

Elsewhere, bond markets are reacting to sluggish economic activity data, which points to near-term recessions in Europe and the UK, as well as the new British government’s focus on tax cuts and additional borrowing to mitigate the impact of a cost-of-living crisis.

PMI readings from Europe, which measures the sentiment of business leaders and operating managers across the region, have fallen below the 50-point mark for three consecutive months, including September, indicating that the world’s largest economic bloc is likely to be in trouble. already stagnant.

β€œThe third quarter clearly represents a turning point for the eurozone economy,” said ING Chief Economist Bert Collin. “After a strong recovery from the deflations caused by the pandemic, the economy is now more sensitive to high inflation at the consumer and producer level.”

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“The manufacturing sector bears the brunt of the problems,” he added. “Supply chain problems continue to hamper production, but weak global demand has caused the backlog to fall with new orders declining rapidly.”

In Britain, Finance Minister Kwasi Quarting, in his first budget statement under new Prime Minister Liz Truss, revealed plans to borrow an additional $80 billion in order to pay both reduced tax fees and a planned cap on energy costs for domestic consumers.

The standard 5-year government bond, the equivalent of Treasuries, suffered its biggest one-day decline since 1991 while the pound fell to a 37-year low of 1.1160 against the dollar.

said Fiona Cincotta, chief financial markets analyst at Citi Index, based in London.

“The Bank of England, which has been reluctant to raise rates sharply, will need to roll up its sleeves and fight inflation by raising rates further,” she added. “Expectations for a 1% rise in November are already rising.”

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