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Bears make a comeback in August

François Christen

François Christen

Chief Economist

The continued strength of the U.S. economy is fueling a sustained "bear steepening" of the dollar yield curve.

Original article published in French on agefi.com

The complacent mood that prevailed in July gave way to doubt and fear in August. Bond markets were not spared, particularly in the USA, where significant tensions drove the yield on the 10-year T-Note to around 4.3%, its highest level since 2007! The same causes producing the same effects as in 2022, the bond correction broke the bullish momentum of equities.

Last week’s surge in yields was fuelled by persistent symptoms of strength in the USA. A fairly accurate reflection of household consumption, retail sales posted a sustained increase in July (1% month-on-month, 5.3% year-on-year, in value terms, excluding cars and fuel), well beyond expectations. The strengthening of industrial production (1% monthly, -0.2% year-on-year, in real terms) also came as a positive surprise. To date, most indicators shedding light on activity point to robust expansion in the third quarter.

However, the picture is not without shadowy areas. Down 0.4% in July, the Conference Board’s composite leading indicator still points to a recession that could materialize in 2024. The decline in the NAHB index (50 in August after 56 in July) suggests that the housing market is being affected by the sharp rebound in mortgage interest rates seen in recent weeks.

The minutes of the last FOMC meeting underline the uncertainty surrounding the economic outlook and the need to base decisions at future meetings on incoming information. Unsurprisingly, the minutes suggest the possibility of a further increase in the Fed funds rate to bring inflation back towards the 2% target. However, some FOMC members raised the risk of “overtightening”. Jerome Powell’s speech at the Jackson Hole symposium will provide a clearer picture of the Fed’s perception and plans in the light of recent indicators. It is unlikely, however, that the central banker will unveil a precise roadmap or provoke a shockwave on the financial markets.

In Europe, sterling-denominated bonds are also under pressure: the yield on the 10-year Gilt reached 4.75% before falling back on Friday in response to the downturn in retail sales in July. Despite a slight upturn in the unemployment rate to 4.2% in July, sustained wage growth (7.8% year-on-year between April and June) should reinforce the Bank of England’s resolve to raise interest rates further to cool inflation, which remains too high (0.3% monthly, 6.9% year-on-year, excluding energy and food).

In the absence of any significant news from the EMU, euro-denominated bonds are displaying stable yields. Falling inflation and a gloomy business climate could prompt the ECB to take a break next month.

On the corporate bond market, the widening of risk premiums echoes the “risk off” regime on Wall Street. Current spreads (averaging around 130 basis points for Investment Grade issuers and 440 bps for the High Yield segment) are still far from reflecting severe stress, which is logical given the firmness of the US economy.

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