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The price to pay for a soft landing

Picture of François Christen

François Christen

Chief Economist

The painful correction in US dollar bonds is mainly driven by a welcome rebound in "real" yields.

Original article published in French on agefi.com

September ended with a bond correction that extends a trend that has been evident for much of the third quarter. The yield on the 10-year US T-Note now exceeds 4.65%, a level not seen since 2007, shortly before the “Great Financial Crisis”. The inversion of the interest rate structure is now less pronounced, foreshadowing “higher for longer” money interest rates, even if the cycle of interest rate hikes led by the Fed seems almost complete (with the possibility of a final 0.25% hike by the end of 2023).

Although the rebound in long-term yields is causing heavy losses for some investors, the “bear steepening” of the yield curve reflects an upward revision of US growth prospects. The Fed’s “pivot”, expected by some as early as 2023, has been postponed until the second half of 2024. It should be noted that the upturn in long-term yields is essentially a consequence of the rise in “real” long term yields, which can be observed in inflation-indexed bonds such as TIPS. The recent bond correction is not the result of an upward drift in inflation expectations, which are still close to the Fed’s 2% target. This suggests that the Fed is seen as credible, but the rebound in real yields could punish the fiscal laxity that led the administration to borrow massively as soon as the “debt ceiling” was suspended at the beginning of the summer.

Recent indicators should encourage the Federal Reserve to maintain a wait-and-see stance. The price index linked to personal spending is showing increasingly moderate monthly growth (0.1% in August, after 0.2% in July and August), in line with the central bank’s targets. Activity indicators are mixed. The sharp decline in consumer confidence (103 in September, after 108.7 in August) could herald a slowdown in consumption. On the other hand, the significant rebound in the manufacturing PMI from 47.6 in August to 49 in September confirms the strengthening of the US economy in the third quarter.

European markets have not escaped the influence of the USA. The yield on the 10-year German Bund continued to rise, to around 2.9%. Recent indicators continue to point to a sluggish economy, which could lead to a slight contraction in eurozone GDP in the third quarter. Year-on-year inflation slowed sharply to 4.3% in September (from 5.2% in August). Excluding energy and food, inflation stood at 0.2% month-on-month and 4.5% year-on-year, below expectations. These developments argue in favor of a lasting, if not definitive, halt to the ECB’s rate hike cycle.

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