Records are being broken
September’s surge in bond yields has continued into October. At one point, the benchmark US 10 year bond yield appeared on course to reach 5% for the first time since 2007. The price of long-dated US treasury bonds is now about 50% lower than its 2020 peak, a bear market comparable with the 2007-09 shock to US equities. Despite such pain being seen in the USA, bond yields either rose less or actually declined in other parts of the world, reflecting the divergent economic paths being seen between North America and across Europe.
Why are US bond yields surging? Two factors are a long-overdue adjustment to a world of higher inflation plus higher government bond supply which needs to be absorbed by the private sector. Inflation is being sustained by commodity prices and tight labour markets, in an environment where recession has been avoided, whilst the tsunami of bonds, notably the budget deficit in the USA is running about 6% of GDP, is occurring at a time when central banks are no longer carrying out massive bond purchase programmes.
In addition, economic data for the USA in September still indicates strong growth rather than recession; some estimates for GDP growth in Q3 are moving well above 3%. The ISM business survey showed manufacturing activity recovered to 49 in September, close to the 50 boom-bust level. The balance between orders and inventories would suggest further improvement ahead. The US services sector PMI survey also held up at 54 last month. Companies appear to be taking on a lot of staff according to the monthly JOLTS employment survey, albeit less so on in an ADP survey, making the next set of official employment figures even more important.
However, the state of the economy is not as good in other countries. China, the world’s second largest economy, remains weak. Manufacturing and services sector surveys only suggest modest growth into year end. The World Bank has lowered its estimate for Chinese GDP growth in 2024 towards 4.0-4.5%. This is rippling through into activity in Europe, as demonstrated by weak German exports in August whilst retail sales across the Eurozone fell by over 1% in August. Manufacturing and services sector surveys for the Eurozone are still at levels suggesting weak growth or modest recessions into the autumn. ECB Governors must also be pleased with the latest inflation news; headline inflation slowed to 4.3% a year in September, the slowest since October 2021.
Economic trends are similar in the UK. Although statisticians revised historical data, now showing that the UK economy expanded 0.5% in the first half of the year, such small changes do not avoid the underlying assumption that the UK remains on a very slow growth path, restrained by a lack of investment. This will not be helped by the news that business confidence fell sharply last month according to Lloyds Bank’s Business Barometer survey, backed up by weak reports from the manufacturing and services sector CIPS surveys. The latest business survey from the Bank of England also suggests price expectations are continuing to fall and the jobs market is cooling.
Where next for central banks? Although markets think the ECB and MPC may have done enough, investors are pricing in a 50-50 probability of another Fed rate hike this cycle. Although Fed Governors such as John Williams consider that the central bank may be done with raising rates as inflation pressures are moving lower, colleagues such as Loretta Mester say the US central bank will likely need to raise rates once more this year and then hold them at higher levels for some time to get inflation back to its 2% target. Future Fed comments about the effect of much higher borrowing costs on the US economy will be watched with considerable interest.
One reason why bond yields in the US and Europe are on a sharply upward path, less so in the UK, is the steady uptrend in debt issuance. In the UK, the Institute for Fiscal Studies warned of a permanent shift to a high tax and high debt economy. In the USA, House Speaker Kevin McCarthy was voted out of office, leading to considerable speculation and greater uncertainty about a government shutdown or delays passing fiscal bills by mid-November. Already Goldman Sachs estimate that the debt servicing burden on the US budget will double from 1.5% to 3% of GDP between 2022 and 2024. About one third of US government debt outstanding will have to be rolled over during the coming year. Investors are clearly trying to find the correct level of bond yields to balance a complicated mixture of weak growth, high inflation, indebted economies, and uncertainty about future central bank decisions – so further records could easily be broken unless perhaps some form of financial crisis arrives as a recalibrating shock to the world economy.
Bond yields at the time of writing
% 2 year 5 year 10 year
USA 5.03 4.69 4.72
UK 4.86 4.55 4.55
Germany 3.13 2.76 2.87
Andrew Milligan is an independent economist and investment consultant. This note is offered as general commentary on economic and financial matters and should not be considered as financial advice in any form.
Andrew Milligan an independent economist and investment consultant. From 2000-2020 he was the head of global strategy at Standard Life/Aberdeen Standard Investments, analyzing the major financial markets for global clients. He currently assists a range of organizations with reviews of their investment processes, advice on tactical investing and strategic asset allocation, and how to include ESG factors into their decision making