What a difference a few weeks make. October was characterized by stern Fed messaging about inflation risks, a surprisingly strong U.S. labor market report and higher than expected inflation.
23.12.2022 | 06:47 Uhr
By October 24, U.S. Treasury 10-year yields were making a new historical high around 4.24%, up 43 basis points(bps) from the end of September. Fast forward to the end of November and things look a lot different. U.S. Treasury 10-year yields ended the month at 3.61%, down a whopping 61 bps lower from their October peak. Real yields joined the party as well with U.S. 10-year real yields down approximately 20 bps over the month, about 50 bps down from their intra-month high. What gives?
First, it wasn’t just the U.S. bond market that rallied. It was truly a global phenomenon. Outside of Japan and a few Emerging Market (EM) countries, 10-year yields fell anywhere from 23 bps in Australia to 185 bps in Hungary. Second, not only did risk-free yields fall, but credit spreads narrowed as well, significantly so in Euro denominated bonds. Third, the U.S. dollar fell significantly. The Japanese yen, for example, rose over 8% versus the dollar from its October low, not coincidentally corresponding almost to the day U.S. Treasury yields peaked. November fixed income total returns measured in U.S. dollars or local currency were truly staggering.
The key to the rally was threefold. Two of which were not so surprising, with the third more so. In October several central banks made it clear they were uncomfortable with raising rates further or uncomfortable with the size of rate hikes. Eastern European central banks were in the vanguard of this movement, but they were joined by the central banks of Sweden, Norway, Australia and Canada. Notably missing from this list was the Fed, who in October took seemingly the opposite stance. The first November surprise was a better-than-expected U.S. inflation report. After many months of disappointment on this front the market embraced this one data point as evidence that inflation had now peaked and was on its way down. Secondly, the U.S. inflation surprise could not have been better timed relative to market positioning. After the surge in yields over October, bond markets were ripe for a correction or at a minimum bear market rally/squeeze. Lastly, the coup de grace so to speak, was the apparent toning down of Fed hawkishness, with more FOMC members vocalizing their belief that enough had been done, at least for now. While in many ways this wasn’t surprising, at some point, the Fed had to start to acknowledge that it had raised rates a lot and needed to slow down/pause to assess its impact. And off to the races we went.