Something odd is happened in the bond market. The yield on the 10-Year Treasury note went back up over 4.00%. It may not last long, but it is rather peculiar. The Federal Reserve has finally lowered its official Fed Funds rate by 50 basis points, its first cut of multiple cuts expected. This is supposed to lower interest rates across the board — so why on earth are interest rates rising?
Before you panic or start thinking a new wave of inflation is immediately on the horizon, there are some market mechanics at work based on demand for Treasuries. Last Friday’s BLS employment report showed 254,000 new jobs and that unemployment fell back down to 4.1% in September. There are also PMI reports holding positive on a national level, even if some regional weakness is being seen.
Oggonomics is looking at why rates have gone back up, but the more important issue is how long you have before they go back down. There is a lot happening. Outside of an election in less than a month, there are many more issues at play. Fed rate cuts, Chinese stimulus, the dollar’s reserve currency status, stronger economic reports, and many more issues to consider.
Is it time to be greedy and buy up the 4% “risk-free” yields? Or is it time to be fearful that even more economic uncertainty will drive yields even higher?
LATEST ECONOMIC SNAPSHOT – BETTER THAN EXPECTED
With all of the companies trimming their workforces, were there really 245,000 new jobs created in September? Some of us do not trust the extreme positive surprise in that BLS report being far stronger than ADP and other data used for forecasting suggested. And many in the public have outright accused the number of being intentionally inflated right before the election. Remember that the BLS had only weeks before revised the March 2023 to March 2024 new jobs downward by 818,000. This was shown to be 5-times greater than the normal margin of error in their stats and it was the worst revision in more than a decade back to shortly after the Great Recession. And there was no crisis or major issue to blame the shortfall on.
What is happening right now to get long-term rates back up is that the market is transitioning from a likely recession back to a soft-landing economic stance. The Atlanta Fed’s GDPNow model for Q3-2024 was updated October 8, 2024 and it was raised to 3.2% GDP growth from its previous 2.5% growth. That has nothing to do with Q4-2024 and the rate cut wasn’t in time to matter much (if any at all) in the Third quarter. The Fed’s GDPNow adjustment was based on multiple reports coming in better:
After recent releases from the US Census Bureau, the Institute for Supply Management, the US Bureau of Labor Statistics, and the US Bureau of Economic Analysis, the nowcasts of third-quarter real personal consumption expenditures growth, third-quarter real gross private domestic investment growth, and third-quarter real government spending growth increased from 3.0 percent, 0.8 percent, and 1.7 percent, respectively, to 3.3 percent, 3.4 percent, and 2.2 percent.
A competing GDP model from the New York Federal Reserve is also indicating better Q3-2024 reporting, and it has started its Q4-2024 modeling. The New York Fed Staff Nowcast for Q3-2024 is 3.1% GDP growth, up a tenth of a percent. Its Nowcast is currently indicating GDP growth of 2.8% for Q4-2024. Just keep in mind that none of the economic reporting and corporate earnings guidance for Q4 have actually started coming in yet.
WHAT LONG-TERM RATES DID
Long-term rates have risen from under 3.65% in mid-September to 3.75% just a week ago and to over 4.05% at the present time. We have to keep in mind that the Federal Reserve does not directly control longer-term rates the same way it manages short-term rates. Fed Funds are controlled by the Fed and that keeps short-term rates in-line under normal circumstances. These are driven by supply and demand of all individual, institutional and governmental buying and selling in the Treasury market.
One issue where the Fed can influence longer-term rates is via open market transactions in the bond market. The Fed’s balance sheet peaked at nearly $9 trillion in 2022. The last Federal Reserve Balance Sheet Trends report showed just under $7.05 trillion. That is the lowest it has been since mid-2020 when the Fed’s economic bailout from Covid was in full force. And the Fed still wants to sell off more.
IS OUR DEBT SPIRAL FINALLY SPIRALLING?
Most economists and investors have discussed the endless US deficit for years and years now. It has been a topic of discussion since the 1980s and 1990s. Unfortunately, it is coming closer to the point at more than 120% of GDP that it could pose severe issues. Imagine if debt servicing (“interest paid to fund the debt”) became the number-one spending item in the budget.
The U.S. Debt to the Penny from the Treasury’s own count showed something quite alarming on top of nearing $35.7 trillion. There was a mysterious jump from just under $35.3 trillion to almost $35.7 trillion in just a few days around the end of the Treasury’s fiscal year. And it was only July 25, 2024 as the last day that the debt was under $35 trillion. It took from January 3 to July 25 (about 6 1/2 months) to rise a full $1 trillion and a pace of less than half that time for the next $1 trillion at the current pace.
We have all heard the debt spiral talk before. But this should be rather alarming if there is not a mechanical issue behind this latest jump.
U.S. DOLLAR GLOBAL RESERVE CURRENCY RISK
The ballooning debt that the United States has issued now is reaching the point where deficit spending and debt servicing is now much closer to the tipping point that will challenge the U.S. dollar’s status as the Global Reserve Currency. Here are just some of the issues that stand out.
Many nations are taking steps to “de-dollarize” when and where they can. Some are obvious like China and Russia. Others may be less obvious. OPEC nations seeking an end to quoting oil in only U.S. dollars is one effort.
The rise in gold and the central bank buying that was seen in the first half of 2024 around the world has been pointed as a potential “tipping your cards” — and IMF data showed in the last 20 years that the US Dollar’s share of total foreign reserves went from about 72% down to about 56% in exchange-rate and interest rate adjusted terms.
The US debt to GDP is now over 120% and rising each day. The theory that the U.S. could inflate its way out of debt was questionable at best, but this has some nations worried about our ability to sustain this trend.
The rise of BRIC nations is actually bringing in more nations, and the elevated valuation of the U.S. dollar makes it more expensive for most emerging market nations to owe money. Moving into other currencies is simply cheaper in the long run.
Moody’s already has a “negative” bias rather than “stable” for the U.S. government, and it recently noted credit effects depend on the policies enacted after the presidential election and the makeup of the government for the coming years have credit risks from possible abrupt and disruptive changes in taxation, trade, investment, immigration and other areas. Was that an even more firm warning of a pending credit rating downgrade?
ELECTION UNCERTAINTY
The presidential election is driving more and more uncertainty. The United States has become more divided than most people can remember. Remember the old saying “Well, we all really want the same thing” that you always heard about American dreams. That’s no longer the case.
How this all plays out will have consequences either way. For the real impact to be seen after the Trump/Harris decision is known and the makeup of Congress is known, we just have to wait to see what actually gets set in policies versus the endless promises and threats that are made during campaigns.
CHINA STIMULUS
China’s economy has been underperforming its growth metrics for quite some time now. China’s economic reports have always faced some international skepticism over the continued growth even in hard times. But things got bad enough in China that after urban youth unemployment (age 16 to 24) was over 21% then China just stopped reporting on that figure.
The PBOC had already lowered its borrowing rate, but the late-September stimulus that was announced sent Chinese stocks up through the roof. The key ETF tracking Chinese stocks (the FXI) rose more than 30% before settling back down around 20% gains in less than three weeks.
China used to be called “the growth engine of the world.” That luster had worn off. Whether this new stimulus gets that rekindled remains to be seen. If it doesn’t, it’s a safe assumption that China can just add even more stimulus to help with housing and development with the hopes that it boosts employment without kindling more inflation.
FUTURE RATE CUTS
As of now, with the dust settling after the strong jobs report and after China’s stimulus, Fed Chairman Jerome Powell is still looking at what is likely another 50 basis points of rate cuts before the end of 2024.
The CME’s FedWatch Tool is still calling for another full percentage point worth of rate cuts by the end of 2025. That is of course highly a “data-dependent” status and the reliability is questionable to guesswork the farther out into the future the tool shows.
Stronger than expected growth will curb rate cuts. A soft-landing scenario should allow short-term rates to go back toward 3.00%. And a recession would allow rates to go even lower.
IN THE END…
The U.S. 10-Year Treasury note was last seen at 4.05%. There is no reason it cannot rise further. Whether it does remains up to market-drive forces around currencies and around the buying and selling (and issuance too) of 10-year Treasury notes.
The WSJ showed the peak in the first half of 2024 above 4.70%. That was when the 30-year bond yield was over 4.80%. These 10-30 year rates are what drive 30-year fixed rate mortgages — and rising long-term rates does not bode well for housing affordability that was already pinched.
Perhaps the main thing to watch for banking and lending levels to remain healthy is the spready between 2-year and 10-year notes. This is currently only about 5 basis points, but it remains positive even if by not much of a margin.
There is no law and no reason that Treasury yields cannot continue rising. That said, there is actually a point that it would no longer make sense. Is that at 4.10%? 4.25%? 4.50%? That is for the market to decide, but unless the globe is on yet another reset trajectory then the backup in rates may just be giving long-term investors another chance to lock in 4% and higher yields in long-dated Treasuries.
And don’t forget the old financial saying that has been around for decades. Treasuries are always supposed to be “risk-free” — as long as you don’t sell before the maturity date.
