The US bond market faces a winter of discontent

Back in September the Powell Fed pivoted to a 50 basis point jumbo rate following two years of draconian monetary tightening, during which the borrowing rate climbed from 0.25 to 5.50 percent.

Unfortunately, the months since the start of the Fed’s easy money pivot have coincided with a quadruple whammy: stronger than expected economic data; inflation angst; dealer hedging in the mortgage backed securities market via the sale of Treasury bond futures contracts; and Donald Trump’s rise in the polls.

This has resulted in a dramatic increase in the world’s benchmark cost of short, intermediate, and long-term capital in the $28 trillion US Treasury bond market, the largest and most liquid debt souk on the planet.

The yield on the two-year US Treasury note, the security most sensitive to a change in expectations of Fed policy, rose from 3.57 percent on the eve of the September Federal Open Market Committee (FOMC) meeting to 4.15 percent in the last week of October.

Widening bond yields are a function of fear as investors demand a greater return for holding what they see as dodgy paper.

The yield on the 10-year Uncle Sam IOU has risen from 3.6 percent on September 18 to 4.3 percent in a mere five weeks.

The GCC’s currency peg means that such a swift rise in the cost of borrowing will engender tighter liquidity and higher rates in GCC bond and sukuk markets, even though all six regional central banks shadowed the Powell Fed’s rate cut in September.

The macro and political storm clouds that triggered the U-turn in bond market sentiment came quickly in the month after the FOMC conclave. September payroll data shocked the Fed. The bond market was also taken by surprise at the 254,000 jobs added – a full 100,000 above the consensus of Wall Street economists. 

Retail sales were also too hot for believers in a Goldilocks conclusion, while consumer inflation data suggested that the Powell Fed was nowhere near its dual mandate price stability target of 2 percent. 

It was no surprise that the most influential policy makers in the American central bank began to dial back on the facile Street consensus that the jumbo rate cut in September would be followed by another 50 basis points at the November 7 FOMC – just after the US election. 

The Atlanta Fed’s Dr Raphael Bostic even suggested that the Fed should skip a rate cut this winter.

The political tea leaves also turned against the bond market bulls as poll data suggested that Trump was gaining fresh voters in swing states like Pennsylvania, Michigan and Wisconsin. 

Modi’s excellent relations with Trump make the Indian rupee bond market a relative safe haven

Trumponomics is anathema to Wall Street bond bulls. The GOP policy agenda is to raise tariffs on all imports, initiate a trade war with China and the European Union and deport millions of illegal immigrants. This means a sharp rise in US consumer inflation and a premature end to the Fed’s easing cycle. 

It did not help that the IMF warned that global public sector debt was a $100 trillion sword of Damocles on the world economy. After all, the US now has 4 percent of the world’s population but 35 percent of its public sector debt. Uncle Sam’s budget deficit in 2024 is $1.8 trillion or a shocking 6.4 percent of GDP. 

An inflation and fiscal sanity risk premium is the ultimate nightmare of the Treasury bond market, whose chickens may come home to roost if Trump is returned to the White House on Election Day.

October payroll data will not end the now-bearish psychology in the bond market as it will be distorted by two devastating hurricanes and the Boeing machinist strike.

World events – from deadly wars, to the LDP’s failure to gain a parliamentary majority following the Japanese election, political gridlock in France on a collision course with the EU, China’s recent Big Bang stimulus, and Britain’s first Labour budget – all argue for higher long-term interest rates. 

• War, oil, safe haven assets and risk premium in the GCC
• Rate cuts will put pressure on Gulf banks’ margins
• Analysts expect ‘mixed’ picture from Gulf banks’ Q3 results

A winter of discontent for the US Treasury bond market is certain; its shockwaves will spare no debt market on the planet.

What to do? A Trump victory scenario can be hedged by selling the Chinese yuan, the Vietnamese dong, the Mexican peso and the Malaysian ringgit, as his tariff diktat will weaken these four currencies.

Among Asian currencies, India’s $700 billion in FX reserves and Modi’s excellent relations with Trump make the Indian rupee bond market the least volatile in Asia and thus a relative safe haven.

The long duration tracker TLT – an exchange traded fund which tracks longer term Treasuries – is also a popular hedging vehicle against higher long-term US bond yield spikes.

In the GCC, Oman’s sovereign credit upgrade prospects may attract new buyers once dollar bond yields stabilise at a higher level.

There you have it.

Matein Khalid is the chief investment officer in the private office of Abdulla Saeed Al Naboodah and the CEO designate of a venture capital firm. He is also an adjunct professor of real estate investing and banking at the American University of Sharjah