What’s behind the volatility in U.S. Treasury yields?

Executive summary:

• Cooling inflation rates are sparking a decline in U.S. bond yields
• The eurozone economy experienced a mild contraction in the third quarter
• China's October retail-sales numbers topped expectations 

On the latest edition of Market Week in Review, Chief Investment Strategist for North America, Paul Eitelman, and Equity Manager Research Analyst Michelle Batjargal discussed the recent volatility in U.S. government bond yields and its impact on markets. They also chatted about the state of the economy in both Europe and China.

Treasury yields fall amid softer U.S. economic data

Batjargal opened the conversation by asking Eitelman to unpack the volatility in U.S. government bond yields over the past few months. Eitelman explained that since July, there’s essentially been two different regimes for bond yields. The first regime, which encompassed much of the third quarter, was powered by strength in the U.S. economy and led to a sharp uptick in yields, he said.

“During the July-to-September period, U.S. gross domestic product (GDP) growth rose at a nearly 5% clip, driven by very strong consumer spending and strong hiring,” Eitelman said. This economic resilience helped trigger a dramatic rise in long-term interest rates, he explained, with the yield on the benchmark 10-year Treasury note jumping approximately 80 basis points (bps) during the quarter.

Since mid-October, another regime has emerged, Eitelman said, characterized by a fall in government bond yields as some weaker economic data points have come through. These include a softer-than-anticipated jobs report for October, weaker business surveys from the Institute for Supply Management and notably cooler-than-expected inflation data for October.

“Together, these reports have started to chip away at the higher-for-longer interest-rate narrative that has dominated fixed income markets the past few months,” Eitelman remarked. He noted that amid these developments, rates have plunged in recent weeks almost as sharply as they rose during the third quarter. For instance, as of market close on Nov. 16, the 10-year yield was off nearly 50 bps from its mid-October peak, Eitelman said. Even more striking, the 10-year yield declined by nearly 20 bps on Nov. 14 alone, following the release of the October inflation report, he said. “Put simply, that’s a very big move in a very short amount of time,” Eitelman commented.

He added that the impact of falling rates on asset-class dynamics has been fairly notable, with U.S. equity markets rallying on the news. As evidence, he pointed to the S&P 500® Index, which is up roughly 5% since mid-October. Other rate-sensitive asset classes have also risen, Eitelman said, noting that the Nasdaq Composite Index is also up significantly, while global REITs (real estate investment trusts) have returned over 7% in the same time frame.

“Ultimately, interest rates have been the key issue for markets for the last several months, and now that rates are falling, markets are reacting positively,” he stated.

European growth contracts while positive economic signs emerge in China

Switching to the latest economic news from Europe and China, Eitelman noted that both areas have been relatively weak spots in the global economy for much of 2023. Europe’s economy continues to look fairly soft, he said, explaining that the eurozone recently reported a 0.1% decline in GDP during the third quarter.

Eitelman explained that a combination of tight ECB (European Central Bank) policy, some weak industrial activity—particularly in Germany—and a cautious consumer has led to sluggish economic activity in the region. “Consumer spending in Europe has been much more restrained than in the U.S., which has helped contribute to the region’s relatively stagnant economic picture,” he noted.

By contrast, there are some signs that China’s economy has started to stabilize in the past few weeks, Eitelman said. While growth has been sluggish for much of the year, particularly due to the country’s ailing property sector, the near-daily announcements of fiscal stimulus measures from Chinese authorities appear to be helping the economy get back on track, he remarked. Chief among these measures is a recently announced US$1 trillion yuan package to support the construction sector, Eitelman noted.

He said that in another positive sign, October retail sales in China topped consensus expectations, rising by 7.6% on a year-over-year basis. “Overall, it does look like China’s economy is showing some encouraging signs of stabilization,” Eitelman concluded.