Treasury Yields Sink as Inflation Retreats

The October reading of the U.S. consumer price index (CPI), a major inflation gauge, reassured investors. The annual rate cooled to 3.2% from September's 3.7%, falling under 3.3% forecasts. Core inflation was also lower than expected at 4%. The good news caused a sharp drop in Treasury yields, with the 10-year bond yield falling by 21 basis points over the week to reach 4.44% while the 2-year yield was down 16 basis points to 4.90% from 5.06%. Only a month prior, concerns about rate hikes had pushed yields on long-term US debt to record highs in recent decades, with the 10-year Treasury yield testing the 5% threshold.

In a context of soft inflation and economic slowdown, few investors still believe that the Federal Reserve will increase rates by the end of the year when financial conditions are already extremely tight and the size of its balance sheet continues to decrease significantly, by more than $45 billion over the past week.

On the contrary, traders now bet on a first rate cut in Q2 2024. June 2024 Fed Fund Rate futures closed at 94.95. This bet is all the more credible as the latest rate increases have presumably not yet impacted the U.S. economy. Interest rate hikes never have an immediate impact. It always takes time for their effects to transmit to the economy.

Against this backdrop, bonds could be a key theme for 2024. It’s worth noting that the U.S. 10-year real interest rate has returned to its level from the 2000s, above the 2% mark.

The downward trend in U.S. Treasury yields has logically spread to the old continent. The 10-year German bund yield lost 13 basis points week-over-week to 2.59% from 2.72%. Similarly, the yield on the French 10-year OAT was down 14 basis points to 3.16% from 3.30%. The movement has been more marked on the Italian debt. The yield on the 10-year Italian Government bond lost 20 basis points. On Friday, Moody's had maintained Italy's sovereign debt rating at Baa3, just one level above junk, but changed the outlook from negative to stable. This unexpected upgrade may be seen as a boost for the government led by Prime Minister Giorgia Meloni.

The riskiest bond segments witnessed sizable weekly gains in the wake of the sharp drop in Treasury yields.

The IBOXX € Liquid Corporates gained 0.94% for the week. In the U.S., the IBOXX $ Domestic Corporates index was up 1.86%. High yield bonds followed suit, with a gain of 0.59% in Europe (IBOXX € Liquid High Yield Index) and a jump of 0.83% in the U.S. (Markit iBoxx USD Liquid High Yield Capped Index). Lastly, emerging debt in local currencies was up 2.10% as the greenback nosedived. The dollar index, a gauge of the greenback's value against six major currencies, tumbled to a 2.5-month low of 103.86 (-1.93%).

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