The markets pay a lot of attention to the short-term fed funds rate which is controlled by the Federal Reserve. The Federal Reserve suppressed long-term yields with QE (Quantitative Easing) by buying large amounts of long-term Treasuries and mortgage bonds during the 2008 financial crisis and Covid but now they are gradually rolling off their book instead of buying.
At the same time, Japan and China have been gradually reducing their Treasury holdings.
At the same time, the U.S. government is issuing a record amount of Treasuries due to growing deficits.
The price of bonds moves inversely to their yields. With a greater supply and lower demand, the price of long-term Treasuries has been falling and their yields rising. This provides a buying opportunity for bond investors, who can divert their capital from risky stocks to the certainty of a rising real yield.
The real yield is shown by the 10-year TIPS which reached 2% this week. This is not high by historical standards. In fact, a real yield of 2% - 2.5% for the 10YT was the norm for decades before the Fed began heavy-handed suppression. There’s no reason why the long real yield should decline in the future. This is a natural, market-set yield.
Rising long-term rates will pressure many companies even though the yield of corporate junk bonds is not rising rapidly. But financial stress is low and the economy is growing at a nice, sustainable rate with low unemployment. There’s no reason for the Fed to change its plan to gradually back out of the market for long-term debt.
The 30-Year Fixed Rate Mortgage Average is rising and now over 7%.
The stock market has languished during August 2023. The CAPE is still in the bubble range although slightly off the highest points. It’s still too early to say whether the downdraft is noise or the start of a trend.
The Fear & Greed Index is neutral. The trade is neutral, neither risk-on nor risk-off. Oil and natgas prices have stabilized. The USD is rising and is at the top of the 2023 channel.
After 15 years of heavy-handed Fed suppression, maybe the crucial price of long-term borrowing is finally back in the hands of the bond market again.
Futures markets show a growing expectation that interest rates could stay higher for longer, exerting pressure on stocks [end quote]
The futures market has been increasing its forecast of the fed funds rate for many months. But that is only loosely connected to the long-term yields.
The METAR for next week is partly cloudy. There’s no reason to expect a sudden negative event. But the growing opportunity for high, safe yields may gradually entice investors away from an overpriced stock market.