Stocks Sank as Bond Yields Hit a 19-Year High. Can the Fed Help?

Stocks swooned as long-term Treasury bond yields jumped to the highest in almost two decades. Can a soothing Fed revive markets?

• The 30-year Treasury yield touched its highest since 2007, unsettling a stock market already short on conviction
• Yields are surging worldwide, and the countries hit hardest are the ones with the heaviest debt burdens
• If the strain is global, American bonds could paradoxically end up the place investors run to

US stocks slipped, though the damage looks more like digestion than a turn. The bellwether S&P 500 and the tech-heavy Nasdaq 100 are still holding the ground they gained in the breakout that carried them higher at the turn of the month, even if volume picked up on the way down. Soggy, in other words, without yet being ominous.

Meanwhile, crude oil is refusing to cooperate with the headlines. Talks between Washington and Tehran are falling apart, with Iran signaling no appetite for a ceasefire and US President Trump musing that the Strait of Hormuz ought to be American territory. Prices nudged higher, yet the move was restrained. Since the US-Iran war erupted in late February, both the highs and lows in crude have narrowed inward, with the market seemingly acclimating to the idea of a long slog ahead.

A 2007 high in long-term borrowing costs

The real disturbance came from the bond market. The 30-year Treasury yield spiked to its highest level since 2007, a dramatic test of long-term US borrowing costs at levels untouched in nearly two decades. That is just the sort of headline that might give equities pause, and so it did. Critically, this is not just a US story, but a global one.

Long-term borrowing costs have climbed across major bond markets, and the order of the damage seems to matter. Robin J. Brooks – the former top economist at the IIF and chief FX strategist at Goldman Sachs – helpfully highlights that since August 7, the steepest increases in 10-year forward government bond yields came in Japan, followed by the UK, France, Italy and Germany. The US placed only sixth. The mildest moves came from places like Switzerland, where the public finances are in better shape.

That ordering tracks fiscal vulnerability, and hints that markets may be anticipating what governments would be forced to do if stubborn inflation squeezes households such that a downturn gathers. With price growth still above target for most major economies, central banks are in no position to cut aggressively, so the burden of fighting any slump would probably fall on the fiscal side.

The economy behind the fear

The risk of a downturn is far from hypothetical. The Atlanta Fed’s GDPNow model has cut its third-quarter growth estimate from around 6% in late July to 4.0% today, trimmed from 4.3% just yesterday after another batch of broadly disappointing US economic data. The “nowcast” will move many more times before the actual figures land in late October. However, the 2% slide in a mere three weeks is an ominous sign of where recent news-flow has been pointing.

Indeed, the latest inputs have been grim. July’s payrolls data came in negative and the prior two months were revised sharply lower. Consumer inflation has eased, but only half of last month’s decline came from the widely expected washing out of the Iran war oil shock. The rest came from core services, a worrying sign for domestic demand. Wholesale prices were soggier still, and measures of retail sales and consumer confidence proved disappointing.

Citigroup’s economic surprise index turned sharply lower this month, warning that economic news-flow is deteriorating relative to forecasts. All the while, breakeven inflation rates embedded in Treasury bond pricing have surrendered the entire wartime oil disruption uplift and now refuse to budge even as crude prices rebound. This warns that the markets are sniffing out a potent disinflationary headwind on the horizon.

The US alone accounts for a hefty 26% of global GDP. July’s purchasing managers index (PMI) data from S&P Global shows it also boasts much faster economic activity growth than the two runners up, China at 17% and the Eurozone at 15% of the worldwide total. This means that if the US economy were to falter, it would probably sink global growth too.

Precious metals seemed to have worked this out earlier than the rest. Gold and silver prices pointedly steadied through July, refusing to decline even as real interest rates surged. That is typically a recipe for pain for non-yielding bullion. The US dollar sold off through the same stretch, even as the real return on holding it ostensibly improved. Both markets seem to be sniffing out that the Federal Reserve might have less room to tighten than the consensus believed.

What the Fed minutes could unleash

Minutes from July’s FOMC policy meeting are the next test. That decision split 9-3, with Beth Hammack, Neel Kashkari and Lorie Logan pushing for a 25-basis-point (bps) hike while the majority held firm. The accompanying statement said activity was expanding solidly, job gains were keeping pace with the workforce, and inflation was still elevated. That sounded hawkish, revealing a committee focused on the fight for price stability.

Nevertheless, the spate of weak economic data since the beginning of this month have eaten away at rate hike bets. Fed Funds futures now price in 22bps in tightening this year, down from 42bps on the eve of the central bank’s July 28-29 conclave. That means a hike by December still looks likely, but no sooner. Moreover, pricing for further tightening in 2027 has been abandoned.

Should the minutes fail to revive the markets’ sense of rate hike urgency, a key event risk marker will have been passed, which may give the green light for tightening bets to unwind further. That may continue to flatter gold and silver prices as well as apply more downside pressure on the dollar. Stocks have yet to reckon with the idea that rate hikes are vanishing from traders’ outlook for all the wrong reasons. They seem to have room to weaken further if growth concerns metastasize.

Why America might end up as the refuge

In a curious twist, US Treasury bonds may end up rising even as traders fret about fiscal stress amid an economic downturn. If the problem is truly global, US government debt might emerge as the least bad alternative. Money fleeing French, Italian, German or Japanese paper has to land somewhere, and the list of alternatives able to absorb it is short to the point of singularity.

Historical precedent on this score is instructive: the greenback rallied ferociously through 2008 even though that year’s crisis was American in origin, because it was the deepest pool of liquidity to cash out into. Treasury bonds could similarly rally if widespread fiscal stress triggers a flight to quality. Tellingly, the 30-year Treasury bond erased losses and closed higher on the session after spiking to a 19-year low intraday.

Ilya Spivak, tastylive Head of Global Macro, has over 15 years of experience in trading strategy. He specializes in identifying thematic moves in currencies, commodities, interest rates and equities. He hosts Macro Money and co-hosts Overtime, Monday-Thursday. @Ilyaspivak

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