The hawks are sleepy, the vigilantes are waking up

After a strong third quarter for bond markets, October was marked by a severe correction on the dollar capital market. For US Treasuries, the losses incurred since the start of the month are close to 2.5%, wiping out almost all the gains made in August and September. The correction intensified last week, pushing the yield on the 10-year US T-Note close to 4.25%.

The Fed’s ‘pivot’ on 18 September, with a 0.5% cut in money market rates, preceded a rise in yields of almost 0.6%! The slope of the dollar yield curve therefore steepened sharply. This shift was initially fuelled by cyclical developments, before being amplified by a reversal in the electoral outlook. The loss of momentum in the Kamala Harris campaign and Donald Trump’s return to the polls has clearly awakened the bond vigilantes, the market players who condemn fiscal laxity.

Pending the outcome of the election, bond investors have opted for caution and are refusing to ‘buy the dip’. This restraint is also justified by the strength of activity in the USA, confirmed by the latest business surveys (composite PMI up slightly to 54.3 in October), the fall in jobless claims and the firmness of orders for capital goods.

Following the elections, the FOMC will meet on 6 and 7 November. A 0.25% cut in the Fed funds rate to between 4.5% and 4.75% is almost certain, but the statement could call into question the ‘friendly’ roadmap unveiled in September. Celebrated by Wall Street, the somnolence of the hawks is not a welcome development for bond investors. Indeed, the rebound in dollar yields is partly attributable to an upward drift in inflation expectations, which might worsen if Donald Trump were to win the presidency. The Republican has admittedly stated that he will not replace Jerome Powell before the end of his term, but his return would entail risks of interference, or even a questioning of the Fed’s independence in the medium term.

On the euro-denominated bond market, yields were stable, at around 2.25% for the 10-year German Bund. Virtually unchanged at 49.7 in October, the composite PMI reflects a sluggish economy that is close to stagnation due to weakness in the manufacturing sector. The first estimate of third-quarter GDP growth due on Friday should reveal barely positive growth, driven mainly by France and Spain.

Against the tide, Swiss franc bonds are showing falling yields. With inflation falling back below 1% and the European environment gloomy, the SNB is likely to cut interest rates further. What’s more, the latest projections from the Federal Finance Administration point to a much smaller annual deficit than expected, at CHF 900 million instead of the CHF 2.6 billion budgeted. In contrast to the lax fiscal policies of the USA, France and Italy, Switzerland’s public finances are in good shape, underpinning the Swiss franc’s status as a safe haven.