Should we celebrate bad news?

Last week saw a sharp fall in US dollar yields. After peaking above 4.7%, the yield on the 10-year T-Note fell back below 4.5%. This fall materialised at the end of the week, after a FOMC meeting whose outcome was certain. Unsurprisingly, the central bank announced that it would maintain the Fed funds rate at between 5.25% and 5.5%, and reaffirmed its desire to maintain a restrictive stance pending a convincing decline in inflation.

While the Fed is in no hurry to cut interest rates, Jerome Powell has stated that a further increase is highly unlikely. The Fed is therefore moving towards an easing deferred by the persistence of inflation during the first quarter of 2024. Slowing the process of “quantitative tightening” by sharply reducing the ceiling on monthly repayments from $60 billion to $25 billion is a “friendly” measure. A lower cap will lead the Fed to drain less liquidity and buy more Treasuries, which should put downward pressure on yields.

However, the Fed’s dovish stance is not the only reason for the decline in yields seen over the past week. A number of indicators pointing to a downturn in business activity and a slackening labour market also played an important role. The ISM surveys point to a slowdown in activity in both the manufacturing sector (PMI down from 50.3 in March to 49.2 in April) and the services sector (49.4 in April after 51.4 in March). The 7-point decline in the Conference Board’s Household Confidence Index seems to be linked to the weakening of the labour market, reflected in the gradual decline in job vacancies and the employment report published last Friday.

Estimated at 175,000, job creation slowed significantly in April. The rise in the unemployment rate from 3.8% to 3.9% and the erosion in weekly working hours reflect a moderation in activity consistent with a “soft landing” for the US economy. This was all it took to rekindle hopes of a first interest rate cut in September, causing yields to fall and risky assets to rebound. In an inflationary environment, symptoms of a slowdown are welcome as long as they do not point to a recession.

In Europe, euro yields are also trending downwards. Inflation continued to fall in April, coming in at 2.7% year-on-year (excluding energy). Service price inflation, which is worrying the ECB, fell from 4.0% to 3.7%. The preliminary estimate of GDP growth in the first quarter reflects a slightly stronger recovery than expected, with a 0.3% expansion following a period of stagnation. Recent events remain consistent with an interest rate cut in June, in line with the many signals from the ECB’s President, Governors and Chief Economist. While sterling-denominated bonds are showing falling yields, Swiss franc-denominated bonds are showing stable yields. The acceleration in inflation seen in April (0.3% monthly, 1.4% year-on-year) could prompt the SNB to show restraint, but a further interest rate cut in June still seems likely.