Over the past six months, the US Treasury has issued $1.5 trillion in Treasuries across bills, notes, and bonds, the second highest level of issuance over the past 25 years, eclipsed only by Covid. While it’s necessary for the US Treasury to issue debt to pay for the ballooning US budget deficit, issuance increases interest rates and borrowing costs. It could also “crowd out” funds available to spend and invest by private individuals and companies, thus slowing economic growth and hurting asset prices.
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Last week’s Treasury announcement, however, might be indicative that we are turning a corner. The government’s intent to issue $776 billion in debt for the fourth quarter was $76 billion lower than expected. Additionally, the upcoming auctions of 3-, 10-, and 30-year Treasuries this week will total $112 billion, lower than the $114 billion expected. While the absolute dollar amount versus expectations is modest, the signal is important – the Treasury is clearly showing sensitivity to the damage that a disorderly rise in long-term interest rates can have on financial markets and the larger economy.
The signal from the Treasury is encouraging, but the long-term trend remains troubling. The recent sharp move higher in bond yields is pricing in a scenario where economic growth slows, and asset prices fall further. The Treasury seems to have taken notice, which has provided near-term relief to bond markets.
The Fed on Hold
The FOMC continues to “proceed carefully,” keeping interest rates steady at 5.50% and focusing on the risks of a slowdown rather than recent strength in growth and labor data. Last week, the FOMC noted that the recent strength in economic activity took place in the third quarter, relegating it to the past, and characterized the job market as having “moderated since earlier in the year.”
As is customary for FOMC press conferences, Fed Chair Jerome Powell tried to strike a balanced tone, noting the FOMC’s focus on downside risk with data dependency should they have to hike rates again. Ultimately, the message for November is dovish, and yields fell throughout the day last Wednesday to account for a Fed that could be done with rate hikes.
The interest rate markets are painting a similar picture through the implied federal funds rate path – the FOMC likely hiked for the last time in July and is expected to embark on rate cuts starting in the second half of 2024.
With the near-term risk of Treasury issuance receding, a Fed that is increasingly focused on an economic slowdown, and the highest bond yields in 15 years, we believe the risk/reward setup for fixed income is highly favorable over the coming months. As shown in the table below, fixed income returns were consistently strong in the last five post-hike periods, with the core bond market returning on average almost 12% in the following 12 months.
*Analysis uses Bloomberg Indices. Past performance does not guarantee future results. All investments are subject to risk, including loss. Indices are not available for direct investment. Any investor who attempts to mimic the performance of an index would incur fees and expenses, which would reduce returns.
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