Pennsylvania Trust

Three Reasons Why Bond Yields Could Actually Rise

Three Reasons Why Bond Yields Could Actually Rise

As we approach the inversion of the 2-year and the 10-year treasury bonds, there are three reasons bond yields may pause or potentially rise in the coming weeks:

  1. Inflation
  2. Deficit Funding
  3. A Trade Truce

Inflation

A key measure of U.S. inflation rose faster than anticipated in July, an outcome that may limit the case for further rate cuts by the Federal Reserve. The core consumer price (AKA CPI) index, which excludes food and energy, rose 2.2%  (blue line in chart) from a year earlier, the most in six months.  While the PCE Deflator Index (the Fed’s preferred barometer for inflation) remains below the Fed’s 2% target, it is highly correlated to the CPI Index hence could post a stronger than expected number when reported next week.

Budget Deficit Funding

As government spending continues to outpace receipts, the Treasury will be forced to issue more bonds than in the past.  The current year’s budget gap is up 27% from the same period last year and has already surpassed the annual deficit from last year ($867 billion vs. $779 billion).

This could put upward pressure on bond yields as the Treasury may issue more bonds with longer-dated maturities in order to manipulate the yield curve… The difference in yield between short-dated maturities and long-dated securities is too small in the eyes of the government hence Increasing supply while maintaining demand would push longer yields slightly higher.

Trade Truce

The U.S. announced that it would delay the 10% tariff on some Chinese products until mid-December. In addition to lowering trade angst, the delay should also help avoid any disruption or additional price increases for American consumers heading into the final four months of the year from back-to-school purchases to Christmas shopping. While the reason for the delay was proclaimed to be for health, safety, national-security reasons, the items being given the delay will include “cell phones, laptop computers, video game consoles, certain toys, computer monitors, and certain items of footwear and clothing” (according to the USTR).

This move sparked demand for risk assets which have been under pressure recently as pundits voiced concerns the trade war would mitigate global growth.

Two additional items to keep on the radar as growing risks are the rising tension in Hong Kong as well as the evolving political and financial crisis in Argentina


Disclosure: This Commentary represents a review of topics of possible interest to Pennsylvania Trust’s clients and is not personalized investment advice. It contains Pennsylvania Trust’s opinions, which may change following the date of publication. Information obtained from third-party sources is assumed to be reliable but is not guaranteed. No outcome – including performance – is guaranteed, due to various uncertainties and risks. This document is not a recommendation of any particular investment. Investment decisions for clients are made on an individualized basis and may be different from what is expressed here. Past performance is no guarantee of future results.