The rise in the 30-yr. bond yield has caught investor attention over the last few weeks, with 5% at risk of giving way on a sustained basis. The yield rise from 0.7% to above 4% from the Covid trough to the 2022 bond sell-off yield peak didn’t make as many headlines. Why panic about 5%? The long term chart below (monthly yield) suggests that the US economy has weathered higher yields in the past. If you think that the yield gains are due to inflation expectations shifting higher, then it may be that 5% yields are still ‘cheap’ if inflation will rip around 5% or higher over the coming years. Given that real yields are popping higher though, it would seem that the current shift to higher yields is based on revised expectations of the US economy doing well over the coming quarters, and potentially dodging a recession in 2024. On a long term Fibonacci ratio retracement view, 6.24% or so is the 38.2% retracement of the drop from 15.21% to 0.7% and serves as a target. The more likely view for the coming year though is that 5%, just above the middle ‘sticky area’ as defined by the flat blue lines on the chart, will be sticky and yields may back away from this test and rotate back to 4% and a bit lower over the coming quarters. The risk is that US economic growth continues to roar in 2024 which may just bring the top blue line near 7% into play – caramba! The long term chart does underline the view that the big bull market in bonds ended. This doesn’t mean that yields will push to 15% again. But it does open up the chance that yields will trade in a big choppy range over the next few cycles, making bond fund managers work a lot harder to earn their keep.
Our more consolidative view on bond yields is by no means a hard technical view, rather it depends on the fact that the US economy is cyclical, and right now we are probably at the tail end of the expansionary part of the current cycle, which leaves a potential slowdown in growth ahead. Inflation? Who knows! The war by Russia in Ukraine shifted a lot of commodity input prices higher over the last year but this may ease over time. The Fed, and other central banks, raised rates a lot higher to stomp on inflation expectations and try to curb worker wage ambitions. The rate hikes take time to work and may come through over the next year. Stocks? The bottom chart shows the 30-yr. bond yield and the S&P 500 (semi-log scale). The first thing to note is that being a permabear of US shares, as many analysts seem to be, has been expensive. The second thing is that rising 30-yr. bond yields don’t have a huge knock on stocks. Instead, as we and most investors suspect, it is the short-end of the market (fed funds) that probably breaks markets when they are raised ‘too high’. Still, given the big rise in yields here over the last 3 years, it would make sense for stock market investors to be wary of downside risk. This is October after all, and the Fed decides on rates on the 1st of November, a late trick or treat?
Gerry Celaya
Chief Strategist
Comments