Oh, would you look at who’s back to spoil the party this week? Well, it is the bond market of course. And surprise, surprise, it’s bringing along the same old problems that Wall Street has been trying to sweep under the rug over the past week.
For all the optimism about easing geopolitical tensions earlier this week, we’re right back to square one or perhaps even taking one step back now. 10-year Treasury yields have climbed up to 5.12% while 30-year yields are pushing 5.45% as we look to end the week.
It’s rather amusing that we’re still running in circles, confronting the same issues that drove yields to multi-decade highs in the first place. I mean, was anything ever really fixed?
Oil prices may have fallen at the start of the week, but fresh reports of strikes in Iran and Trump declaring that the US doesn’t need a deal with Tehran have quickly poured cold water on hopes of any lasting reprieve. Yup, pretty much a case of déjà vu and that is nothing new when it comes to the US-Iran conflict. We’ve been down this road one too many a time over the last eight months.
As such, that leaves the threat of another energy-driven inflation shock hanging over markets. And it’s not as though the latest inflation numbers are giving the Fed much room to breathe either.
The October CPI report saw headline prices rise 0.4% against expectations of 0.3%, while core inflation also surprised higher at 0.3%. Well, so much for the thought of inflation quietly disappearing into the background.
When you put those two together, the higher for longer narrative is proving to be rather stubborn. And the backdrop gets even more uncomfortable when you have Washington continuing to pile on debt at a time when borrowing costs are already painfully high.
The latest numbers this week showed that the US posted a record $404 billion budget deficit for October, up from $284 billion a year earlier. That’s hardly reassuring when the government needs investors to keep financing its spending. And it’s evident that those very same investors aren’t exactly waiting in line to lend money to the government. The latest $25 billion 30-year Treasury auction saw the bid-to-cover ratio slip to 2.36 from 2.54 previously, underscoring weaker demand at the long-end of the curve.
The trouble with all this is that it goes beyond just what the Fed does next.
At this stage, investors want greater compensation for the uncertainty of holding government debt. That is especially the case as inflation risks continue to linger and Washington’s borrowing needs are showing little signs of slowing down.
In essence, that’s the term premium that the bond market is talking about. Or to put it more simply, if I’m lending you money for 30 years, you’d better make it worth my while.
Now, a Fed pause might provide some temporary relief for broader markets. However, that won’t magically make those bigger picture concerns disappear in an instant.
So, what does this mean for Wall Street?
Well, tech shares have been under the microscope in recent weeks and the latest developments here will only increase the scrutiny on them moving forward.
In the past few weeks, investors were already getting nervous about the enormous AI infrastructure spending and whether those investments could eventually justify their lofty expectations. And Nvidia’s recent woes have only shaken confidence further.
So now, you’re adding in another problem to that. Or should I say, a familiar problem that we have been talking about since August and September i.e. surging bond yields. Higher Treasury yields will make future earnings less valuable in today’s money, while also raising financing costs for companies spending heavily on growth. That’s a troubling thought that is coming at the wrong time when investors are already questioning how much they’re willing to pay for the AI dream.
All that being said, I’m not suggesting that a major crash in tech stocks is inevitable. But with 10-year yields starting to nudge back up above 5% again, it is worth keeping in mind that tech stocks don’t quite have as much breathing room as they once did in terms of trying to withstand another push higher in borrowing costs.
As much as markets want to celebrate falling oil prices or the prospect of an eventual Fed pivot, I struggle to see how either solves the fundamental problems weighing on bonds. We’re still dealing with sticky inflation, persistent fiscal deficits and the fact that investors are demanding more to finance US debt.
And until something changes, I reckon the bond market will keep finding ways to haunt Wall Street about the same old problems that never really went away.
This article was written by Justin Low at investinglive.com.