Bond Markets Navigate US Economic Resilience and Shifting Fed Policy
Deutsche Bank's economic review highlights that bond markets are balancing strong US economic activity against concerns over tightening financial conditions and shifting Fed rate expectations.
According to Deutsche Bank's economic review, bond markets are entering the fourth quarter torn between robust US economic activity and growing concerns that high yields themselves are tightening financial conditions.
August PCE inflation data and September employment figures were weaker than expected, but consumer spending remained strong. Jobless claims and the ISM manufacturing survey also pointed to resilient activity and ongoing pressure on input prices.
Yields initially rose following the data, but subsequently reversed course as concerns over financial strain and more dovish remarks from the Federal Reserve gained greater weight. The market-implied probability of an October rate hike dropped from about 70% at the beginning of the week to less than 20%. The weaker employment report further reduced the urgency for another near-term rate hike by the Fed.
In Europe, the pressure is more acute. France's budget proposal failed to reassure bond investors, and the yield spread between France and Germany widened beyond 140 basis points. Looking ahead, the minutes of the Federal Open Market Committee (FOMC) meeting, to be released on October 7, and the European Central Bank minutes, due on October 8, will outline how policymakers weighed inflation against the financial tightening already caused by rising market yields.
"As we presented in our quarterly economic and asset allocation outlook, PERSPECTIVES, solid fundamentals and attractive carry continue to support high-quality credit, while high yields justify a selective approach regarding duration and lower-rated issuers," the economists noted.
US Economic Resilience and FOMC Outlook
Key economic releases this week include the ISM and PMI services surveys. The ISM Services Purchasing Managers' Index is expected to edge down slightly from 55.4 to 55.2, while the final S&P Global US Services PMI is expected to confirm the strong flash reading of 58.7.
On Wednesday, market participants will focus on the release of the minutes from the September 16 FOMC meeting, after the Fed stated that the 25-basis-point rate hike, supported by all 12 voting members, was designed to best support its dual mandate amid continued employment growth and robust productivity gains.
In summary, the US economy remains resilient, but softer September job growth points to a cooling labor market. The ISM services PMI and FOMC minutes will help determine whether the Fed can continue to show patience despite remaining high inflation pressures.
