- With less than a week to go to the US election and polls showing a deadlock, with neither candidate taking a clear, outside the margin of error, lead in the battleground states, Treasury markets have been turning bearish as investors second-guess whether their portfolios are ready for either outcome. Volatility has increased with the ICE BofA Move Index, a closely watched gauge of US bond-market volatility, closing at its highest levels this year on Monday. With continued signs of US economic strength, short-dated US Treasury yields have surged on markets pricing out Federal Reserve rate cuts. The market's attention, in the run up to next week’s Fed meeting will be on September’s Personal Consumption Expenditures (PCE) data, the Fed’s preferred inflation gauge, due for release on 31 October and the September NFP on 1 November. CPI data for September suggests that services inflation measured by PCE could begin to rise given wage growth.
- The dollar index has risen for the majority of October and closed at 104.21 yesterday. It is more than +3% YTD and +3.6% this month, its strongest monthly performance since April 2022. The US labour market continues to show some signs of slowdown with the September JOLTS report indicating a significant drop in job openings, falling to 7.443 million, well below the anticipated 7.9 million and marking the lowest level since March 2021. This represents a substantial 1.9 million decrease y/o/y. The number of lay-offs edged slightly higher to 1.2% or 1.8 million while the quits rate remained relatively stable at 1.9% or 3.1 million. Markets will be looking at September's total nonfarm payroll, average hourly earnings and employment data on Friday for further indications of the possible depth and pace of future Fed rate cuts.The consensus forecast for Friday's nonfarm payrolls report is 120,000 jobs added, less than half of September's 254,000 figure. However, it is important to note that this data may be influenced by distortions arising from recent hurricanes and the ongoing Boeing strike.
- On the growth front the flash Composite PMI in October increased to 54.30 points in October from 54 points in September. The Flash US Services Business Activity Index came in at 55.3, up slightly from September’s 55.2. In short, the economy is still showing solid strength. GDP increased at a 2.8% annualised rate in Q3 after rising 3% in the previous quarter. Consumer spending, which comprises the largest share of economic activity, advanced 3.7%, the most since early 2023. The acceleration was led by broad based spending increases including autos, household furnishings and recreational items.The personal consumption expenditures price index, excluding the volatile food and energy components was 2.2%, down from the 2.8% pace in the second quarter.
- In addition, consumers are feeling more confident. The Conference Board's consumer confidence index increased in October to 108.7, surpassing the consensus forecast of 99.4 and up from September’s revised reading of 99.2. This marks the strongest monthly gain since March 2021 and the highest overall level since August 2023. According to October’s reading, all five components of the Index improved. Consumers’ assessments of current business conditions turned positive. Views on the current availability of jobs rebounded. Compared to last month, consumers were substantially more optimistic about future business conditions and remained positive about future income. The Present Situation Index—based on consumers’ assessment of current business and labor market conditions—increased by 14.2 points to 138.0. The Expectations Index—based on consumers’ short-term outlook for income, business, and labor market conditions—increased by 6.3 points to 89.1, well above the threshold of 80 that usually signals a recession ahead.
- Nevertheless, despite the positive news, Treasury yields continued to steepen this month as investors focused on election uncertainties. The yield on the 2-year Treasury note, which is highly sensitive to movement of the Fed Funds rate, had risen from 3.539% in September to 4.095% by 29 October. The benchmark 10-year US Treasury note yield has also continued to rise. It ended on 29 October at 4.255% from September’s 3.729%, while the yield on the 30-year bond had also risen from September’s 4.084% to 4.488%. The Treasury Department announced on Wednesday total quarterly refunding of $125 billion from November to January 2025, aimed at raising $8.6 billion from private investors. The $125 billion in Treasury securities will refund about$116.4 billion of privately-held Treasury notes and bonds maturing on 15 November. In a statement, the Treasury said it will sell $58 billion in U.S. three-year notes, $42 billion in 10-year notes, and $25 billion in 30-year bonds next week. These were the same auction sizes for the same securities announced at the July refunding. On Monday, the Treasury announced its intention to borrow $546 billion in Q4, representing a $19 billion reduction from its July estimate. According to the CME FedWatch tool, there is a 96% chance of a 25-basis-point cut at the 6th-7th November meeting. However, the probability of a 25 bps reduction at both the November and December meetings is currently estimated at around 75%.
Yield swings
US Treasury yields have climbed throughout October on signs of a still resilient US economy and election uncertainty.
Source: FactSet
Source: FactSet 6:15 PM EDT 29 October 2024
Global Economic and Market Review
In the UK, inflationary pressures continued to fall with the headline rate in September coming in at 1.7% year-on-year, down from August’s 2.2%. Core inflation measured 3.2%, while services inflation remained elevated, although down to 4.9% from August’s 5.6%. According to the UK’s Office of National Statistics (ONS), average earnings excluding bonuses rose 4.9% in the three months through August from a year earlier. Private sector wage growth slowed to 4.8% from 5%. The UK's unemployment rate fell to 4% in the latest three months, however vacancies fell by 32,000 to 841,000 in the three months through September, the lowest since the spring of 2021.
On the growth front the UK appears to be struggling. October data pointed to a moderate increase in UK private sector output, but the rate of expansion slowed for the second month running to its lowest since November 2023. The composite PMI fell to 51.7, down from 52.6 in September. This was an 11-month low. The services PMI business activity index fell to 51.8, down from 52.4 in September, also an 11-month low. The Flash UK Manufacturing PMI came in at 50.3, down from September’s 51.5 and a 6-month low. Real GDP is estimated to have grown by 0.2% in the three months to August 2024 compared with the three months to May 2024. Services output was the main contributor to the growth in the three months to August, rising by 0.1%. Gross domestic product is estimated to have grown by 0.2% in August 2024, after showing no growth in July 2024. The Office for Budget Responsibility (OBR) has now forecast that real GDP growth will be 1.1% this year from close to zero last year, 2.0% in 2025, and 1.8% in 2026, and then fall back to around 1.5% thereafter. However, as the government has extended the freeze on personal tax thresholds during the budget announced today, this fiscal drag might continue to slow the economy down. Consumer confidence fell again in October to -21, down one point from September. The index measuring changes in personal finances over the past year was down one point at -10, while the outlook for the next 12 months was up one point at -2.
Bank of England Governor Andrew Bailey has said disinflation in the UK is happening faster than officials had anticipated. The BoE is widely expected to continue to ease policy at its next meeting on 7 November by 25 bps to 4.75%.
In the eurozone, the ECB cut rates again on 17 October by 25 bps, lowering the deposit rate to 3.25%. Markets are fully expecting a further 25 bps cut at December's meeting. Eurozone inflation fell to 1.7% in September 2024, down from 2.2% in August. Core inflation - excluding volatile items such as food, energy, alcohol, and tobacco -fell to a five-month low of 2.7% in September, down from 2.8% in August. Services inflation fell slightly to 3.9% from August’s 4.2%. On the growth front, the eurozone HCOB flash Composite PMI came in at 49.7, a slight nudge above September’s 49.6). However, theHCOB Flash Eurozone Services PMI Business Activity Index came in at 51.2, down from September’s 51.4 and an 8-month low. Growth in the eurozone came in at 0.4% in Q3, above expectations of a 0.2% rate. However, industry remained in recession and household consumption barely grew. This higher than expected growth might support arguments to maintain a gradual pace of easing. According to Bloomberg news, traders have priced in around a 25% chance of a half-point cut in December. Earlier this month, the implied probability was 50%, according to swap pricing. Given the weak state of the eurozone’s largest economy, the German economy, which is seeing a weakening of its labour market and an inability to sustain its manufacturing base, markets are more realistically considering a 25 bps cut in December.
The benchmark German 10-year yield was +20.60 bps as of 29 October at 2.340%, while the UK 10-year yield was +32.20 bps as of 29 October at 4.315%. The spread between US 10-year Treasuries and German Bunds expanded by more than +29 bps over the month. It currently stands at 192.76, significantly up from September’s 159.2 bps. The gap between Italy and Germany's 10-year yields, a gauge of investor sentiment towards the eurozone's more indebted countries, is, according to Worldgovernmentbond.com, now at 121.7 basis points, down from September’s 133.4 basis point differential.
Global bond markets are likely to remain volatile in Q4. As noted by the IMF in its October report, downside risks are rising and now dominate the outlook: an escalation in regional conflicts, monetary policy remaining tight for too long, a possible resurgence of financial market volatility with adverse effect on sovereign debt markets, a deeper growth slowdown in China, and the continued ratcheting up of protectionist policies. The risks of widening tensions in the Middle East have not fully dissipated, the ongoing war in Ukraine is likely to become even more complicated depending on who wins the US election and there is still signs of growing trade fragmentation due to rising tariffs between the US, Europe and China, which will continue to affect yields and, in turn, the US dollar. There are also unresolved policy issues related to immigration in the US, UK and Europe that will affect labour markets, government revenues, and fiscal priorities. In addition, despite some fiscal policy measures and a loosening of monetary policies, the ability of China to increase domestic demand may make energy prices more volatile in the short to medium term.
With less than a week to go until the US elections, investors will have to consider the potential changes in US election outcomes with the consequent implications for the repricing of government debt and term premia.There is speculation that both candidates will boost fiscal stimulus. Although this may spurr growth, it would also spurr inflation. It would likely be funded by increasing debt levels with the supply of Treasuries driving up yields. Therefore, investors may wish to consider adding in some inflation protection into their portfolios along with yield-spread targeting. With downside growth risks, particularly in Europe, now outweighing upside inflation risks, the bond-equity correlation may be returning to negative territory. Although the ECB is likely to continue to cut rates, it remains cautious with guidance being very limited. The big concern is that the ECB, the Fed and even the BoE may be seeing their inflation targets as a floor rather than a long-term average. This means that inflation could, on average, be higher than the current 2% target. This outcome doesn’t appear to be priced into current inflation expectations.
Key risks
- Inflation risks re-emerge, weighing on asset prices. Although inflation is falling in Europe, the UK and the US, services costs, particularly in Europe, are still an issue for consideration. There are also risks that headline inflation may rise due to commodity prices rising, particularly for gas in Europe. Yields on longer-dated Treasuries that are most sensitive to the inflation outlook have risen throughout most of October.
- Policymakers over or undershoot. Central banks are being very cautious about getting the balance between supporting their economies while fighting future inflation risks. In Europe there have been warnings that the ECB could undershoot the inflation rate (causing people to delay spending and further weakening economic growth). There are potential headwinds to the dollar as well. It should be remembered that a significant variation in the timing and size of rate cuts, will also cause currency volatility.
- Geopolitical tensions and events. Tensions in the Middle East are still high and the continuing war in Ukraine is still a large risk for European economies, particularly as we are approaching the winter heating season. The tensions in the South China Seas between China and the Phillipines remains an issue for Association of Southeast Asian Nations (ASEAN) members with the leaders of the 10-member group calling for speeding up the adoption of a long-awaited code of conduct for the South China Sea at their October 2024 summit. However, the biggest risk remains the US election outcome and how quickly a winner will be certified. Given the closeness of the polls, the votes, particularly in swing states, are likely to be contested, giving way to lawsuits. A Trump victory could have diverging rate implications. It would likely result in increased inflation (following an increase in tariffs), but may push bond yields lower outside the US as the ECB in particular looks like it may frontload cuts.
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