Market Minute: Pay Close Attention to the Bond Market

The appetite for equity risk has been undoubtedly strong post-election. Attention then quickly shifted to the FOMC meeting yesterday where a 25-basis point rate cut was all but assured. As the S&P 500 (SPX) inches closer to the psychological 6,000 level, volatility as measured by the VIX has compressed and havens such as utilities and gold stepped back. Market participants are repricing expectations for rate cuts from December moving forward with uncertain legislative and executive branch policies in mind. 

Despite a combined 75 basis point cut to the Fed funds rate since September, the 10- year Treasury yield has risen to almost 4.5% this week. This has widened the yield curve to the benefit of banks and wholesale lenders who borrow short term and lend long. A pattern of stronger economic data in the past month or so may be the focal reason for the bond sell-off. Other considerable factors include higher expectations of inflation due to uncertain trade and immigration policies beginning next year. The bond market may also be pricing in lower taxes and higher Federal spending which requires added financing. In addition to legislation or executive policy factors, the Fed’s shrinking balance sheet where existing Treasuries gradually roll off the books continues to increase the supply of long-term bonds issued by the Treasury to the private sector institutional markets. The bond market seems to be paying close attention to the risks, resulting in higher interest rates and lower equity valuations.