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Since the Federal Open Market Committee lowered rates in September, Treasury yields have moved in the opposite direction across both the long and short ends of the yield curve. The 2-year Treasury yield, which closely tracks expectations for the Fed Funds Rate, has risen from 3.61% on September 17th to 4.1% as of October 30^th. The 10-year Treasury yield closed at 3.64% before the Federal Open Market Committee surprised markets with a 50-basis point cut. Since that decision, the 10-year yield has climbed to 4.26% as of October 30^th. This article will explore possible reasons for these rising yields and discuss their implications for investments.

Smooth Landing
 

Economic indicators have shown improvement since summer, when the unemployment rate reached 4.3%. Recent data reveals job growth of 254,000 in September, with unemployment falling to 4.1% and average hourly earnings up by 4%. The ISM Non-Manufacturing Index saw a slight acceleration, retail sales up 0.4% in September, and consumer sentiment has risen for three consecutive months, according to the University of Michigan's October report last Friday. September's new home sales increased by 4.4% month-over-month, supported by declining yields ahead of the Fed's policy decision. Although Wednesday's advance Q3 GDP report showed a slight drop to 2.8%—below the Atlanta Fed’s GDPNow forecast, which had been over 3%—this was largely due to a decrease in exports from Tuesday's Advance Economic Indicators. Still, a 2.8% growth rate is solid for a developed economy, suggesting a continued trajectory toward a soft or no landing scenario.

Source: Atlantafed.org

However, the outlook isn’t entirely positive for the US economy. Inflation remains persistent, and the Fed is far from declaring “mission accomplished.” The core Consumer Price Index (CPI), which excludes food and energy, rose 3.3% year-over-year in September, slightly up from 3.2% in August. On a brighter note, shelter costs—the largest component of core inflation—had their smallest increase since June, rising just 0.2%. Despite this, the core CPI’s 3.3% increase still stands well above the Fed’s 2% target.

The Fed’s October Beige Book noted little change in overall economic activity since September, with manufacturing declining across most districts, though two reported modest economic growth. Hurricanes primarily impacted crops and tourism, and the dockworker strike had minimal effect. Loan demand has been mixed; while lower rates have improved the outlook, housing affordability and uncertainty about future rate direction remain challenges. The job market has held steady, with hiring focused more on replacement than expansion, and districts report that finding workers has become easier.

The Citigroup Economic Surprise Index tracks how actual economic data compares to estimates. Readings over 0 suggest the data is beating market expectations. Seeing a rise in this number does correlate well with a rise in interest rates as of late.

Source: https://yardeni.com/charts/citigroup-economic-surprise/

With positive job data but persistent CPI inflation, many now expect the Fed to proceed cautiously with any rate cuts. Earlier this month, Fed Governor Christopher Waller remarked that "monetary policy should proceed with more caution on the pace of rate cuts than was needed at the September meeting.” On October 21, Dallas Fed President Lorie Logan added, “If the economy evolves as I currently expect, a strategy of gradually lowering the policy rate toward a more normal or neutral level can help manage risks and achieve our goals.” Atlanta Fed President Bostic said he’s open to skipping next week’s rate cut after the release of the September CPI report showed a core CPI of 3.3% year over year.

As the Fed meets next week to decide on monetary policy, the CME FedWatch Tool, which tracks 30-day Fed Funds futures, currently reflects a 94.6% probability of a quarter-point cut as of October 30. With Q3 GDP still positive and unemployment steady since its summer peak of 4.3%, bond traders appear to be dismissing a hard-landing scenario. Initially, the risk of a hard landing was a concern due to the Fed’s delay in rate cuts while unemployment rose, but the recent 50-basis point cut may signal the Fed’s resolve to prevent further increases in unemployment.

Coordinated Easing
 

Another reason that may be causing rates to rise is a result of central banks easing at the same time. With central banks across the globe cutting rates, prospects of economic growth instead of recession are going up. These are the central banks that are cutting rates:

• The European Central Bank: Three times to 3.25% from 4%.
• Bank of Canada: Three times since June to 4.25% from 5%.
• Swiss National Bank: Three cuts to 1% from 1.75%
• Bank of Japan: Raising rates, but anticipated to hold steady for the rest of the year
• People’s Bank of China: Two rate cuts in 2024 for the one-year loan prime rate to 3.1% from 3.45%
• Bank of England: Cut once in September and economist think they will again on Nov 7^th.

As we can see from the list above, the Federal Open Market Committee has been a little late to join the party. That may be another reason why the bank cut rates 50-basis points instead of 25 to catch up to the other central banks. Given that so many banks are now easing off the brakes, it’s leading to a better sense for the global outlook.

The OECD Economic Outlook produces a report twice a year with its recent publication titled "Turning the Corner”. The OECD raised their global growth from 3.1% in May to 3.2% in September siting “further disinflation, improving real incomes, and less restrictive monetary policy in many economies helping underpin demand.” They also state that some risks remain, particularly in trade tensions, the possibility labor markets could cool, and possible deviations to the disinflationary path for prices; and yet, they also said the improvement in real incomes could help stabilize consumer spending.

The International Monetary Fund hasn’t changed their mind in their October report. The IMF recently stated that growth remains stable yet underwhelming. They also stated that upgrades to their forecast were made for the United States, offsetting downgrades to other developed countries, mainly in Europe. The IMF is predicting that on average, emerging market and developing economies should grow their GDP by 4.2% in 2024 and 2025. While the global outlook hasn’t changed much, the IMF upgraded the US outlook.

Fiscal Spending
 

With the presidential election just a week away, the race between the two candidates is close. Recently, the Committee for a Responsible Federal Budget published an article titled The Fiscal Impact of the Harris and Trump Campaign Plans, assessing the potential effects of each candidate’s fiscal policies on the federal deficit. The analysis highlighted that both candidates will face significant fiscal challenges, including “record debt levels, large structural deficits, surging interest payments, and the looming insolvency of critical trust fund programs.”

According to the report, both candidates’ plans would likely increase the deficit. Harris’s policies could add approximately $3.95 trillion to the deficit by 2035, while Trump’s could increase it by around $7.75 trillion, based on recent campaign statements. These figures represent average estimates within a wide range and do not consider potential changes in GDP resulting from their policies. What is clear, however, is that neither candidate appears focused on fiscal responsibility, with both projections pointing to an elevated debt-to-GDP ratio of 125% or even higher.

Source: https://www.usdebtclock.org/

We’ve seen bond vigilantes take measures into their own hands when it comes to government spending. The European sovereign debt crisis from 2008 to 2012 wasn’t that long ago. High government spending and deficit spending required bailouts and backstops from the International Monetary Fund and the European Central Bank. Greece’s long-term interest rates shot up close to 30%, Portugal near 14%, and Spain near 13% at the peak of the crisis.

Credit default swaps, insurance on bond defaults, for US Treasuries were elevated in 2023 when Congress negotiated over the debt-limit, but remain low at this time. Interest rates may be moving up in recent weeks as both presidential candidates have begun to layout their fiscal plans, and neither appear worried about the growing budget deficit. Particular attention has been drawn to the interest payment on our debt, which is eclipsing the defense budget. The committee for a Responsible Federal Budget stated neither candidate’s plan would be sufficient to put an end to rising debt, and that it would take a policymaker focused on cutting spending to put America on a sustainable path.

Defense on the Bench
 

Defensive sectors have underperformed in recent weeks because investors may be writing off the scenario for a hard landing and moving out of these areas. These areas often trade like bonds and go up in value as investors buy bonds, driving yields lower. The opposite is true if investors are dumping bonds on better economic prospects and turning to growth areas, thus causing yields to rise. These areas include Consumer Staples, Health Care, and Real Estate. Utilities are also considered a defensive sector, but recent data center deals and profitability for the sector have possibly changed the way investors traditional view it as a defensive sector in light of the power demand for data centers in addition to electric vehicle mandates that may require more power generation.

Source: Stockcharts.com, Ryan Puplava, CMT® CTS™ CES™

Inflation Protection
 

One possible indicator that rising interest rates may be tied to increasing inflation expectations is the climb in inflation-protected assets like precious metals and cryptocurrencies. This trend may also reflect a "flight to safety" by investors, fueled by recent geopolitical tensions in the Middle East and an upcoming contentious election. While these factors help explain recent movements in gold prices, they don’t account for the year-to-date gains: gold is up 35% this year, having been on the rise since talks of interest rate cuts began earlier this year.

Another plausible explanation for gold's ascent is growing demand from central banks and countries seeking to bolster their currencies and reduce reliance on the U.S. dollar in foreign reserves. A recent Goldman Sachs article, Gold Predicted to Climb Higher Than Expected as Records Shatter, argues that central banks are increasingly purchasing gold following the freeze of Russian central bank assets in 2022. This trend may also be driven by the stark disparity in gold holdings between developed and emerging nations, with the latter potentially catching up to diversify their reserves amid record-high U.S. debt. Data from the World Gold Council shows gold comprises 72% of the U.S. foreign reserves, 71% for Germany, 68% for Italy, and 69% for France, compared to just 4.9% for China and 9.5% for India. This disparity suggests countries like India and China may continue to buy gold for years to come.

Source: https://www.goldmansachs.com/insights/articles/gold-predicted-to-climb-h...

Conclusion
 

In summary, today’s economic indicators and market movements reveal a complex landscape shaped by persistent inflation, shifting Fed policies, and global uncertainties. While inflation remains a challenge, steady job growth, retail sales, and increased consumer sentiment provide some positive momentum, albeit with caution around future rate decisions. On the fiscal side, neither presidential candidate appears poised to prioritize debt reduction, likely leading to a further rise in the debt-to-GDP ratio. Rising interest rates have played a role in placing certain sectors on the performance bench. Meanwhile, inflation fears and geopolitical tensions have heightened demand for inflation-protected assets like gold, with central banks bolstering their reserves in a strategic pivot from US dollar reliance. Taken together, these elements underscore the delicate balance between economic stability and the pressures of inflation, geopolitical risk, and rising national debt that continue to influence gold’s price and demand.

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