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Markets Got an Unexpected Boost From Washington. Could It Be a Turning Point?

November 5, 2023
minute read

The Treasury Department pleasantly surprised investors last week, and now the question is how far they can capitalize on it.

Both stocks and bonds experienced rallies, receiving a boost when the Treasury decided to increase the size of longer-term debt auctions by a smaller amount than many had anticipated.

By the end of the week, the yield on the benchmark 10-year U.S. Treasury note, which had been a source of market anxiety, had dropped back down to 4.557%, after briefly reaching over 5% on October 23. The S&P 500 saw a 5.9% increase for the week, largely due to relief over the decline in yields, which significantly affect U.S. borrowing costs.

Yields, which fall when bond prices rise, were also pushed lower by soft economic data and indications from the Federal Reserve that it is unlikely to raise interest rates again this year. However, many viewed the Treasury's actions as the key catalyst.

There had been a debate before last week about what had caused the surge in yields in recent months. Some analysts pointed to the strong economy and expectations of a higher path of short-term interest rates set by the Fed. Others emphasized an imbalance in the supply and demand for Treasurys, exacerbated by the increased size of longer-term debt auctions needed to fund a growing federal budget deficit.

Regardless of the cause, investors seized upon an event that is typically overlooked—the Treasury's quarterly announcement of its upcoming borrowing plans—as a significant market moment.

As it turned out, the Treasury not only announced smaller-than-expected increases in longer-term debt auctions but also indicated a willingness to exceed informal guideposts for issuing short-term Treasury bills.

In terms of dollar amounts, the difference between what Wall Street had anticipated and what the Treasury delivered was relatively small, but investors interpreted it as a meaningful message.

Typically, the Treasury aims for "regular and predictable" auctions with gradual changes in borrowing strategies announced well in advance. Now, the agency has shown a willingness to be more flexible and responsive to the market, according to John Madziyire, head of U.S. Treasuries at Vanguard.

The Fed also delivered a similar message on the same day. While the Fed held short-term rates unchanged, as widely expected, its policy statement included a new reference to tightening financial conditions, a subtle change from its previous statement in September that investors perceived as an acknowledgment of the rise in bond yields.

The relief was evident across Wall Street, with the S&P 500 achieving its largest weekly gain in almost a year after experiencing a correction. Sectors sensitive to higher bond yields, such as real estate and information technology, saw significant gains. The index maintained a 14% increase in 2023.

However, investors caution that favorable developments from Washington alone may not be sufficient to sustain the rally. Strong corporate earnings are essential, and next week includes reports from companies like Walt Disney and D.R. Horton.

Both the Treasury and the Fed are pursuing their own goals, with the Treasury seeking to minimize funding costs and the Fed focused on controlling inflation while avoiding a recession.

Lower yields, all else being equal, can stimulate economic growth by reducing interest rates on mortgages and corporate debt. However, it is uncertain what the ideal level of interest rates is to control inflation without harming the economy.

Investors were generally satisfied with last week's economic data, which mostly fell short of expectations, contributing to the drop in yields. Following reports of the economy growing at a robust 4.9% rate in the third quarter, investors have been hoping for a slowdown to prevent further increases in yields and to avoid additional inflation.

Nonetheless, it is a delicate balance, and some investors expressed concerns about the jobs report on Friday, which unexpectedly showed an increase in the unemployment rate and a narrowing of industries adding to their payrolls.

There is a prevailing concern that high rates will eventually catch up with the economy.

On the flip side, inflation remains above the Fed's 2% target, and some are concerned that achieving the Fed's inflation goal will remain challenging, particularly after last week's bond rally made borrowing cheaper once again.

Sonal Desai, chief investment officer of Franklin Templeton Fixed Income, suggests that the recent rally might be overdone. She emphasizes that while the Treasury may appear to support the market, there is a limit to how much it can do due to the size of the budget deficit.

Editorial Board
Eric Ng
John Liu
Editorial Board
Bryan Curtis
Adan Harris
Managing Editor
Cathy Hills
Associate Editor

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