Bond yields climbed, even as U.S. inflation eased
Why did long-term bond yields rise even as inflation cooled?
Wednesday brought the inflation data the bond market had been waiting for. Core PCE (the Personal Consumption Expenditures Price Index, a key measure of U.S. inflation) rose by 0.2% in August against 0.3% expected, and odds of an October interest-rate hike fell from about 51% to roughly 35%. Short-term yields and the U.S. dollar dipped on the release. However, within hours of the news, both moves had faded.
Long-term bond yields went the other way. The 10-year Treasury yield closed September at 5.29%, its highest level since 2002, up by about 55 basis points (0.55 of a percentage point) on the month and marking a seventh straight monthly increase, a streak last seen in 2011. The 30-year Treasury yield reached 5.63%, its highest since June 2002, after rising seven sessions in a row. The U.S. Treasury tripled its long-bond buyback to $6 billion, but the markets barely noticed.
This is the clearest signal yet that the U.S. Federal Reserve (the Fed) has lost control of long-term interest rates. Short-term interest rates follow directions from Fed Chair Kevin Warsh. Long-term bond yields follow deficits, the supply of U.S. Treasury and corporate debt, and oil (with the price of Brent crude up by more than 40% from its June lows). Investors want more compensation to lend for thirty years, and one soft inflation report does nothing to change that math.
Why are U.S. credit spreads widening fast?
While attention stayed on Treasury yields, U.S. credit moved faster. The ICE BofA high-yield spread jumped from 2.66% on September 21 to 3.08% by Tuesday, more than 40 basis points (0.4 of a percentage point) in about a week. The damage is worse among the lowest-rated bonds, with CCC spreads near 968 basis points , their widest since November 2023 (meaning investors want 9.68 percentage points more in interest to lend money to the highest-risk corporate borrowers than for government bonds). Supply explains much of it. September saw high-yield bond sales of $38.5 billion, the busiest month of the year, led by a $10 billion SoftBank deal; also, Paramount is looking to raise another $44 billion through bonds this week.
Stocks ended the quarter a couple of percentage points from their highs, while credit investors demanded steadily more to lend to weaker companies. Today this is a supply problem. It will become an earnings problem if the window for borrowing narrows for the companies that need it most.
How did Canada's economy perform?
Two Canadian headlines landed Tuesday. Statistics Canada reported that gross domestic product was flat in July after three months of growth, with construction and utilities up while manufacturing fell by 0.9%. The same morning, a U.S. ban took effect on roughly $967 million of Canadian imports (87% of it alcohol plus certain dairy products and motorcycles). Quebec will feel that last one directly, with Bombardier Recreational Products' Can-Am Spyder and Canyon three-wheeled motorcycles now barred from the U.S. market, though the company expects the impact to be felt mainly next year. The S&P/TSX Index (which tracks the stock prices of Canada's biggest companies) closed Monday at its lowest level in nearly two months.
Both headlines are smaller than they sound. The advanced estimate shows August growth of 0.2%, and economists track the third quarter to be at 1.5% to 2% annualized (which is close to the Bank of Canada's forecast). The ban covers about 0.1% of $880 billion in two-way trade. The real pressure on Canada will arrive through the bond market; rising global yields will lift Canadian borrowing costs and tighten financial conditions the Bank of Canada never chose.
What will the upcoming earnings season tell us?
After a week when inflation cooled, long-term bond yields rose anyway, and credit started demanding more, the question is simple: will the bond market let stocks enjoy any good news at all? We can't wait for third-quarter earnings in two weeks to give us something to cheer about.
Listen to the latest podcast from the IG Investment Strategy Team for further insights.
