The Treasury Department handed investors a happy surprise last week. Now the question is how far they can run with it.
By the end of the week, the yield on the benchmark 10-year U.S. Treasury note—the source of so much recent anxiety in markets—had fallen all the way back down to 4.557% after briefly topping 5% on Oct. 23. The S&P 500 climbed 5.9% for the week, largely reflecting relief over the decline in yields, which are a critical driver of U.S. borrowing costs.
Yields, which fall when bond prices rise, were also pulled lower by soft economic data and hints from the Federal Reserve that it likely won’t raise interest rates again this year. But it was the Treasury move that many saw as the crucial catalyst.
Heading into last week, there had been debate about what had caused yields to surge in recent months. Some analysts pointed mostly to the strong economy and expectations for a higher path of short-term interest rates set by the Fed.
Others emphasized what they saw as an imbalance in the supply and demand for Treasurys, worsened by a recent increase in the size of longer-term debt auctions needed to fund a widening federal budget deficit.
Whatever the answer, investors seized on a normally overlooked event—Treasury’s quarterly announcement of its coming borrowing plans—as an important moment for markets.
As it turned out, Treasury on Wednesday not only announced smaller-than-expected increases to longer-term debt auctions but also suggested that it was willing to overstep informal guideposts for how much in short-term Treasury bills to issue.
Just based on dollar amounts, the difference between what Wall Street had anticipated and what Treasury delivered was small. But investors embraced what they saw as the underlying message.
Typically, Treasury strives for “regular and predictable” auctions, with gradual changes in borrowing strategies telegraphed well in advance. Now, the agency has signaled that it is willing to bend on that mantra and be “more sensitive to the market,” said John Madziyire, head of U.S. Treasurys at Vanguard.
Further aiding markets, the Fed delivered a similar message later the same day. At the conclusion of its two-day policy meeting, the Fed held short-term rates unchanged, as widely expected. But in a policy statement, the central bank made a new reference to tightening financial conditions, a small tweak to its previous statement in September that investors interpreted as a nod to the increase in bond yields.
“Really it was just a wonderful coincidence,” said Brian Jacobsen, chief economist at Annex Wealth Management. First came Treasury’s borrowing plan, he said, “and then the Fed just fanned the flames of the enthusiasm by suggesting that we are in that holding pattern with rates.”
Relief was palpable across Wall Street. The S&P 500’s weekly gain was its largest in almost a year, coming right after it suffered a correction, declining more than 10% from its July peak. Sectors that are particularly sensitive to higher bond yields, such as real estate and information technology, were among the biggest gainers. The index is holding on to a 14% advance in 2023.
Even so, investors strongly cautioned that friendly moves out of Washington won’t be enough to sustain the rally. For starters, corporate earnings will need to come in strong, with this coming week featuring reports from the likes of Walt Disney and the home builder D.R. Horton.
Neither the Treasury nor the Fed is committed to sparing investors from losses, analysts noted. Both are pursuing their own goals, with the Treasury seeking the lowest possible funding costs and the Fed interested in bringing down inflation while avoiding a recession.
Lower yields, all else equal, should aid economic growth by lowering interest rates on such things as mortgages and corporate debt. But it is still unknown what perfect level of interest rates can curb spending just enough to control inflation without breaking the economy.
Investors were generally pleased with last week’s economic data, which mostly came in weaker than expected, thereby aiding the decline in yields. After recent data showed the economy growing at an eye-popping 4.9% pace in the third quarter, investors have been hoping for a slowdown, both to keep yields from rising further and to avoid another acceleration in inflation.
Still, it is a highly delicate balance, and some investors expressed unease about Friday’s jobs report. That data showed an unexpected uptick in the unemployment rate and a narrowing in the industries that are adding to their payroll.
Many investors worry that it is only a matter of time before high rates finally catch up to the economy.
On the flip side, inflation remains above the Fed’s 2% target and has even shown signs of ticking up recently after a summer cool-down. Just as some investors worry about a recession, others are concerned that it will still be difficult to achieve the Fed’s inflation goal, especially after last week’s bond rally made the cost of borrowing cheaper again.
“I think that potentially the rally we’ve seen over the last couple of days is overdone,” said Sonal Desai, chief investment officer of Franklin Templeton Fixed Income.
There is an idea that “the Treasury has the market’s back, [but] it can’t,” she added. “The size of the budget deficit means that there is an absolute limit to how much the Treasury can do.”
Write to Sam Goldfarb at firstname.lastname@example.org
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