Evening Brief – 10.02.02
Bond Vigilantes: They’re Baaaack!
The financial markets have continued to be tested over the first two trading days of the fourth quarter, largely mirroring the final two weeks of the third quarter.
The S&P 500 was down more than 1.5% on Tuesday as US Treasury yields resumed their upward trajectory. The US 10-year Treasury yield jumped to a new 16 year high of 4.80%, while the US 30-year Treasury yield reached its highest level since 2007 at 4.94%.
Despite better-than-anticipated economic data to start the week (Manufacturing PMI improved to 49.0 in September from 47.6 in August, and JOLTS job openings for August were 9.61 million versus 8.800 million predicted), risk assets remain under severe pressure, with WTI crude oil slipping back below $90 per barrel.
Wall Street analysts are warning about the impact of rapidly rising interest rates on the equity markets, with Goldman Sachs, Morgan Stanley, and JPMorgan all predicting additional losses.
“We had not anticipated such an increase in rates,” said Vincent Juvyns, global market strategist at JPMorgan Asset Management. “This is something which will at least slow down, or even reverse the progress of equity markets.”
The price action in the bond market appears to validate CNBC analyst Rick Santelli’s assertion on Monday’s Fast Money segment that bond vigilantes are back in full force. Santelli even projected that the US 10-year Treasury yield may reach 14%!
Coined by investor Ed Yardeni, president of Yardeni Research, in the 1980s, bond vigilantes refer to investors seeking to rein in government spending by orchestrating a selloff in the US Treasury market.
The rout in the bond market comes at a time when the Federal Reserve’s restrictive monetary policy stance is nearing an end, which would suggest rates should be peaking, not shooting to the moon.
“We have a lot of potential room to the upside,” Santelli added. “Worst case scenario, where are Treasury rates going to go? 10-year, I’d say in the next seven years you should be able to see 13.5% or 14%. Vigilantes have new horses, and they are riding.”
Indeed, with 10-year yields at 4.80%, the asset allocation decision for equities is getting quite difficult.
This week’s Treasury selloff comes on the heels of US politicians averting a government shutdown, causing traders to strengthen their bets that the Fed would hike interest rates in November.
Two Fed policymakers backed up that assessment, with Cleveland Fed president Loretta Mester indicating on Monday that another rate hike was probable, and Governor Michelle Bowman encouraging additional hikes.
The CME FedWatch Tool places the odds at 31% of a 25-basis points rate hike atr the November policy meeting and 47% for December.