Risk of selling bonds increases due to ‘no-landing’ scenario and strong stock market

After the benchmark 10-year yield briefly topped 5% as recently as late October, investors and traders have become complacent with the narrative that inflation will continue to decline in 2024, enough to require multiple interest rate cuts from the Federal Reserve. Now a hotter-than-expected January report could begin to upend that thinking and risks scorching anyone who had hoped Treasury yields would continue to fall from last year’s highs.

Economists have downplayed the chances of a U.S. recession and the Dow Jones Industrial Average DJIA and S&P 500 SPX were marching toward more records despite some loss of momentum Friday morning. Meanwhile, strategists at BofA Securities pointed to the possibility that the 10-year Treasury yield BX:TMUBMUSD10Y would need to rise closer to 4.5% compared to Friday’s level of about 4.25%.

Nancy Tengler, CEO and CIO of Laffer Tengler Investments in Scottsdale, Arizona, said there is more room for the stock market to rebound. The company had $1.2 billion under management as of December. She compared the current environment to the 1990s, when inflation averaged more than 3%, 10-year yields hovered between 5% and 7%, and stock prices soared.

Read more: Wall Street is bracing for stronger U.S. economic and inflation data next week.

Nonfarm payrolls growth was surprisingly strong in January at 353,000, and the consumer price index for that month showed inflation continuing to be a problem. The data shows that “despite all these fears of overheating, stock markets have risen over time, so it’s more about a no-landing sentiment than a soft landing, or a ‘boom-flation’ where growth stays high but inflation remains high.” Close, said Will Compernolle, macro strategist at FHN Financial, exceeding the Fed’s 2% target.

“Yields need to be higher to compete with capital appreciation, but a 5% 10-year yield is unlikely to materialize,” he said by phone Friday. “I support the idea that the January data was a fluke and that subsequent inflation and labor data will show that the overheated U.S. economy is not a new trend.”

Nonetheless, confidence in the U.S. growth outlook will push longer-term Treasury yields higher between now and June, when many expect the Federal Reserve to make its first rate cut, pushing markets toward higher yields between October and January. It could be a blow to banks that have returned to power. According to Compernolle, the peak has been reached.

The likelihood of a no-landing scenario is small but growing. On Tuesday, the Deutsche Bank DB team
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Interest rates markets are pricing the probability of such a scenario at 10% to 25% this year, based on December overnight index swaps, he wrote. George Efstathopoulos, an Asia-based Fidelity International money manager who sold most of his 10- and 30-year Treasury bonds in December, told Bloomberg the no-landing scenario was growing.

Federal funds futures traders have backed off expectations of six or seven quarter-point rate cuts by December, but are betting on the possibility of at least three such moves. In contrast, options traders linked to collateralized overnight interest rates have been interested in the idea of ​​another rate hike from the Fed.

From now until June, “the focus will be on inflation,” said Eric Sterner, CIO of Apollon Wealth (Mount Pleasant, S.C.), which manages about $7 billion. “We know the last mile will be difficult and arduous. The biggest question is, ‘Will consumers and the labor market remain resilient?’”

In an interview with MarketWatch, Sterner stuck to his base case view of the Fed cutting rates by three-quarters of a point this year and argued against the notion that a bond market sell-off is imminent in a “no-landing” scenario. In his view, “interest rates will eventually fall in part because the Federal Reserve will likely cut rates at some point this year. We believe the economy is slowing, even though it has been more resilient than many expected.”