Chronicle of May 2024
The Dynamics of Treasury Yield
A promising month turned turbulent as Treasury yields skyrocketed. The 30-year Treasury yield surged to 4.7%, one of the highest in 15 years, jolting the stock market. Now, fears of even higher yields and deeper corrections are looming. What causes yields to go up or down?
The case for rising yields
Several developments during the last few days have caused an uptick in Treasury yields. The U.S. Producer Prices Index (PPI) was released in mid-May, and it was significantly higher than expected (0.5% MoM real vs. 0.2% consensus). Because the PPI tends to precede core inflation, a higher PPI would result in higher inflation, limiting the Fed's ability to lower interest rates further.
This was followed by a series of Fed officials who spoke hawkishly about interest rates. The last one was Neil Kashkari, the Minneapolis Fed President, who said that the Fed “could stay on hold for indefinite period of time”, and that none of the Fed officials “has totally taken rate increases off the table”.
The subsequent Treasury auctions were noticeably weaker than usual. The May 28th auction had a bid-to-cover ratio of 2.3x, the lowest since September 2022. With more than $600 billion in debt sold that week, Treasury demand cannot be considered weak, but it is weaker. According to some analysts, the absence of Chinese Treasury purchases could be to blame. Whatever the reason, this causes concern in the bond market.
Comments by high-profile figures, such as Jamie Dimon, CEO of JP Morgan, may add to the yield increase. According to Jamie Dimon, the Fed's next action could be to raise interest rates further. Interest rates could rise to 8.0% as a result of continuing inflationary pressures and strong government spending.
The case for falling yields
The arguments for lower Treasury yields revolve around lower inflation and the interactions between the Fed and other countries' central banks.
From mid-2022 to mid-2023, the inflation rate was clearly declining, but it continues to hover between 3.0% and 3.5%. In the past few months, U.S. inflation has been below expectations. In the latest one, in April, monthly inflation was 0.3%, lower than the expected 0.4%. Jobs data also suggests a little slowdown. In April, the U.S. economy added only 175,000 jobs, falling short of the expected 235,000. The jobless rate also increased to 3.9% from 3.8% the previous month.
The latest Beige Book, a summary of the Fed's commentary on economic conditions, also showed a muted outlook due to economic uncertainty.
Central banks around the world have ceased raising interest rates, and some have started to cut them. For example, the European Central Bank is projected to decrease interest rates by the middle of the year to aid the struggling European economy.
Another argument for lower yields is that even if the Fed holds rates unchanged, U.S. interest rates are higher than those of other countries, which will cause the USD to become relatively strong and decrease U.S. economic competitiveness. Thus, the Fed's next action is unlikely to be an interest rate hike.
Mixed market reaction
While a declining yield is theoretically beneficial to equities and vice versa, the reality is far from clear. Sometimes, a declining yield might result in lower stock prices. Especially the first interest rate cut that may be interpreted as a recession warning because almost all rate cuts occurred after, or shortly before, the economy entered recession.
Are yields on the rise or decline? The ever-shifting macroeconomy makes it essential to remain invested.