Recent Surge in Bond Yields

Recently, there has been a noticeable uptick in the yields of U.S. government bonds, particularly on the longer end of the Treasury yield curve. The 10-year Treasury note, for instance, reached a yield of 4.3% on August 21, marking the highest level since 2007. Meanwhile, short-term yields have remained relatively stable throughout the month of August.

Inflation and Market Expectations

Contrary to what one might expect, the latest U.S. inflation data does not appear to be driving the sell-off in Treasury bonds. Recent reports indicate that inflation rates have actually been slowing down. Moreover, market expectations regarding the Federal Reserve’s future actions on interest rates have remained largely consistent. The majority of investors anticipate that the Federal Reserve will maintain current interest rates at its upcoming meeting in September. Market sentiment concerning the subsequent Federal Reserve meeting in November also remains evenly split on the likelihood of a rate hike.

Three Key Drivers of Rising Yields

Resilient U.S. Economy

The American economy’s resilience in a high-rate environment is leading investors to reconsider what the equilibrium, or neutral, interest rate might be in the coming five to ten years. The neutral rate is essentially the interest rate at which monetary policy neither accelerates nor decelerates economic growth. Recently, there has been a shift in market sentiment, raising this neutral rate to nearly 4%, which in turn is contributing to the elevated bond yields.

Increase in Treasury Bill Issuance

Another factor at play is the surge in the issuance of Treasury bills, which has altered the supply dynamics in the U.S. government bond market. This greater supply could be making the demand for higher Treasury yields more likely.

Global Factors

On the global stage, certain events, like the Bank of Japan’s recent decision to ease its control over the yield curve of its 10-year government bonds, may also be affecting U.S. Treasury yields. Previously, Japan had acted as a global anchor, keeping yields low. The easing of this control is potentially lifting Treasury yields.

Investment Implications

For investors, the increase in bond yields might represent an attractive opportunity in fixed income. Yields of 4% or 5% could offer a compelling hold-to-maturity return on low-risk government bonds. Additionally, if economic conditions worsen, Treasury bonds could serve as a source of capital appreciation.

Insights from PMI Surveys on the European Economy

Economic Slowdown Globally and in Europe

Recent preliminary PMI surveys released in the week of August 21 offer some of the earliest reliable indicators of global business cycle health for the month. The data suggests a gradual slowdown in business activity worldwide, except for Japan which stands as an outlier. The slowdown appears to be more pronounced in Europe.

European Economic Conditions

Europe, like the United States, has been grappling with high inflation rates and has responded by raising interest rates to restrictive levels. Additionally, European banks have tightened lending standards considerably due to economic uncertainties. Unlike in the United States, however, banks in Europe have a more significant role in the real economy, which might explain why the region is experiencing a faster slowdown.

Conclusion

While the global economy is showing signs of cooling, the effects seem more noticeable in Europe. This could be attributed to the larger role that banks play in the European economy, making it more sensitive to changes in lending standards and interest rates. Overall, the slowdown is still largely marginal but warrants close attention moving forward.