Update Bonds: Market volatility climbs
US Treasury yields have been sliding this week as markets continue to scale back expectations of aggressive rate cuts by the US Federal Reserve. The US economy remains strong, and some Fed members have hinted at a slower pace of future rate reductions. Federal Reserve Governor Christopher Waller noted that recent data show the economy is not slowing as much as anticipated.
The next Fed policymaker meeting is 7 November, just two days after the US presidential election. The possible prospect of a Trump presidency, along with the Republican Party possibly gaining control of Congress, potentially leading to higher import tariffs and larger fiscal deficits, adds to market concerns.
Ten-year Treasury yields rose above 4.2% for the first time since July. (As bond yields rise, bond prices fall.) Since the Fed cut its policy rate by 50 basis points in September, two-year Treasury yields have increased by more than 40 basis points. The nervousness in the bond market is best illustrated by the Move Index, which hit its highest level this year. The Move Index measures US bond market volatility, similar to how the VIX index tracks volatility in the equity market.
The rise in US Treasury yields affected European bonds. German ten-year yields touched the highest level since September, although German two-year yields remain close to the low seen earlier this month. Investors have more doubts about the strength of the European economy. Futures markets currently see a 40% chance of a 50 basis-point rate cut by the European Central Bank in December. The divergence in interest rate expectations continues to support the US dollar relative to the euro.
We continue to believe that European investment-grade bonds are attractive. They offer competitive yields and could benefit from falling interest rates. Bonds with longer duration are likely to gain most from lower yields.
Peter Bossaer
