Control Panel: Long-term Treasury bond rout

When stock prices plunge, investors usually call it a “falling knife.” When bond prices plunge, investors often call it a “rout.” Since bond yields move in the opposite direction of bond prices, a “bond rout” corresponds to a spike in interest rates.

The Federal Reserve has been tightening monetary conditions to control inflation since 2022. They have raised the short-term fed funds rate and also are gradually allowing some of their massive book of longer-term Treasuries and mortgage bonds to roll off (mature without replacement). (“Quantitative Tightening” or QT.)

Despite the monetary tightening, which was expected to result in a slowing economy and probably a recession, the U.S. economy remains strong.

The Atlanta Fed’s GDP Now model estimate for real GDP growth (seasonally adjusted annual rate) in the third quarter of 2023 is 5.4 percent on October 18. That is unusually strong growth. It’s well above the “Consensus Estimate” of 2.5%, which itself is quite strong growth. That would be considered an economic expansion, far from a recession.

It’s typical for interest rates to climb during an economic expansion, since demand for credit grows. At the same time, the government is running record deficits while the Fed and other large Treasury buyers are shedding rather than buying Treasury debt. To make matters worse, there may be a government shutdown in a month.

Bond Rout Drives 10-Year Treasury Yield to 5%

The benchmark for U.S. borrowing costs has climbed at a rate alarming to investors

By Sam Goldfarb and Peter Santilli, The Wall Street Journal, Updated Oct. 23, 2023

A deepening selloff in the U.S. bond market drove the yield on the 10-year U.S. Treasury note to 5% for the first time in 16 years, extending a rout that has rattled stocks, lifted mortgage rates and fueled persistent fears of an economic slowdown…

For all the debate about what has fueled the latest, more acute selloff, most investors agree that the 10-year yield rose in the summer due largely to bets that interest rates would stay high for longer… [end quote]

This article discusses how higher 10 year Treasury (10YT) yields feed into credit products that impact the real economy, from mortgages to business lending and more.

The change in 10YT yields is so steep that it begs the question: is this only the start of a continuing trend that could result in still-higher yields? Higher yields would pinch the economy but are also typical of expansions. Or could the trend abruptly reverse, which has happened before? Lower yields are typical of a weaker economy which would be reflected in lower stock prices.

Another Black Monday May Be Around the Corner

The Federal Reserve’s policies threaten the American economy and financial markets.

By John Greenwood and Steve H. Hanke, The Wall Street Journal, Oct. 22, 2023

The Federal Reserve’s policies are threatening U.S. financial markets and the economy. They are in danger of a steep recession and the risk of a repeat of 1987’s Black Monday…

Between July 2022 and August 2023, the M2 supply contracted by 3.9%, the most extreme contraction since 1933. … The second factor contributing to shrinking M2 is the decreased availability of commercial bank credit — the sum of loans and bank holdings of securities…

The money supply has been contracting for 18 months, and soon, after the overhanging extra money from 2020-21 has been used up, spending will plunge and inflation will fall, not simply to 2%, but below — and perhaps even into deflation in 2025. … [end quote]

Deflation would be a bad thing for owners of TIPS. Economists generally abhor deflation due to consumers delaying purchases in expectation of lower prices later.

Significant drops in M2 and commercial bank lending are rare and associated with recessions. TMF has a good article about this.

The Conference Board Leading Economic Index® (LEI) for the U.S. declined by 0.7 percent in September 2023 to 104.6 (2016=100), following a decline of 0.5 percent in August. The annual growth rate of the LEI has been negative, indicating weaker economic activity ahead, since April 2022. Despite this, the economy has been strong. Either the indicator isn’t working anymore or there has been a long lead time with a recession in the future.

The Control Panel shows both stock and bond prices falling at the same time. I picture the markets as a bathtub where the Federal Reserve controls the level of water (money). It’s not surprising that asset prices rose when the Fed was pumping money with negative real yields. It shouldn’t be surprising that asset prices are falling when the water level is dropping.

The S&P 500 peaked in August and has been falling since then. The Fear & Greed Index is in Fear. The risk panel is neutral since stocks and bonds are falling together. USD and oil have stabilized. VIX is rising but is not to a worrisome level yet. Financial Stress is low so there’s no concern for a financial crisis caused by the rising yields.

The Treasury Yield Curve is rising, especially at longer durations. It is now almost flat. This is interesting because the past behavior of the yield curve is to invert before a recession but then to flatten and become positive just before the recession begins. That’s because the Fed usually cuts the fed funds rate to counteract the recession.

At this time, the Fed intends to hold the fed funds rate constant (new data dependent) since the increase in the longer term yields is at least as likely to slow the economy as changes in the fed funds rate. The Fed wants to slow the economy to reduce inflation.

The METAR for next week is rainy. There’s a negative bias but not stormy. The markets are gradually responding to worrisome events. I don’t think there will be strong moves next week. However, the markets are in a vulnerable place since the S&P500 CAPE is still near a bubble high and the bond market is in “falling knife” mode. Anything that erodes investor confidence could result in sudden, strong market moves.



The thing that’s amazed people who work in the bond market is the recent volatility. Not just 1 or 2 sigma deviations, but sometimes even wider!

For example, the 10-year briefly hit 5%, which caused a furor, and then promptly dropped rapidly to 4.8% again a day later. Right now, for example, it is trading at 4.82%.


The thing that was wider was the zero percent FF rates.

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