Rising bond yields boost the dollar

Wall Street adopted a significant "risk off" sentiment this morning as Treasury yields continued to rocket, now 4.78% at ten years, pushing the dollar to new highs over 107. Nasdaq fell hardest, off 1.6%. Oil prices passed the $90 mark. The VIX traded above 20 for the first time since May in morning trade, reflecting elevated fear levels on Wall Street.

Bottom line: risk-off.

TODAY’S MAJOR NEWS

Where will the rise in bond yields take us?

Yields on 10-year Treasuries are trading near 4.78%, fresh 16-year highs, and well above the 3.25% level we saw in April. Yields on 2-year Treasuries also rose, trading near 5.14%. How much further could yields rise? It’s worth considering where real bond yields are trading.

US real interest rates are close to 0.5%, much lower than the 40-year average of 2.75%. Economists accept this as the long-term average real rate, equating to long-run economic growth rates. On this target, bond yields would need to rise to 6.05%. Alternatively, the market is anticipating inflation falling back to 2%. Experts wonder if the Fed's 2% inflation target will soon be achieved. Thus, 10-year bond yields could continue rising to 6% or more, putting pressure on corporate and mortgage rates, corporate profits, and the valuation of equity markets.

Real and nominal 10-year bond yields, %

Source: St. Louis Fed.

Fed’s hawkish messages

We continue to hear hawkish talk out of the Federal Reserve, with some members saying openly that we’ll need to see restrictive policy for “some time” to bring inflation down to the 2% mandate. They call it a mandate to add weight, but it’s an arbitrary target. The Federal Reserve has repeatedly stated that it is committed to the 2% level, so we must take them at their word.

Fed members understand that the US consumer-driven economy is primarily driven by perception. Bringing inflation down means reducing demand to match supply. As such, the Fed seeks to slow down the economy to reduce the demand for goods. It’s doing so by lowering the M2 money supply. Real M2 money stock, adjusted for inflation, is currently at $6.9 trillion, up from $6 trillion at the pandemic's start. That’s getting close to trend supplies of cash on hand, so consumers are now reaching into their credit cards to continue spending.

Higher interest rates are meant to discourage borrowing to reduce demand, which has a more significant impact if consumers worry about the economy. However, they feel freer to use those credit cards if they think the economy is turning the corner, increasing demand again. Thus, the Fed focuses on maintaining the rhetoric to suppress consumer buying by keeping interest rates high.

Increased job openings reinforce the tight labor market story

• Today's Job Openings and Labor Turnover Survey (JOLTS) report showed a more significant than expected jump in job openings at the end of August, repeating the same message of a tight labor market we’ve seen in other data
• The Fed will find this worrying, given that a tight labor market equates to higher wage costs and rising inflation
• The number of job openings on the last business day of August stood at 9.6 million, the US Bureau of Labor Statistics (BLS) reported, well above an expected 8.8 million jobs – and this followed 8.9 million (revised from 8.8 million) openings in July
• The report also showed a decline in the job quitting rate, a sign of confidence among workers
• Friday’s Non Farm Payroll data is forecast to see 170,00 additions in September after 187,000 in August, but the data tends to overshoot

TODAY’S MAJOR MARKETS

Nasdaq falls hardest in weak equity markets

• Nasdaq fell hardest in morning trade, off 1.6%, in response to rising bond yields. The S&P 500 and Russell 2000 fell 1.3%
• Foreign markets continued to catch up with US market weakness, with the Nikkei 225, Dax, and FTSE 100 off 1.6%, 1.1%, and 0.5%
• The VIX, Wall Street’s fear index, rose to 19.5

Bonds see major sell-off, dollar benefits

• 10-year yields traded down up to 4.77%, and 2-year yields rose to 5.15%
• The dollar index rallied 0.2% to 107.1
• Versus the dollar, the Yen, Euro, and Sterling, and the Yen were down 0.5%, 0.1%, and 0.1%, respectively

Oil rallies over $90

• Crude oil prices rose 1.3% to $90 per barrel
• Spot gold prices fell 0.2% to $1,843 per ounce, while silver was unchanged at $21.4 per ounce
• Grain and oilseed markets were weak in morning trade, with some fund short-covering in wheat
• Corn and soybean prices are under pressure from better-than-expected harvest results amid weak demand
• Lean hog futures saw follow-through selling from Thursday's bearish USDA hogs and pigs report, while the cattle market gave way to the above headwinds

Analysis by Arlan Suderman, Chief Commodities Economist: [email protected]

Market outlook by Paul Walton, Financial Writer: [email protected]