It's been a long time since the start of August was so hectic, and the change in mood so radical.
From a situation where bad economic news was greeted as a fairly positive sign, paving the way for a rate cut in the US, it has now turned negative again.
What ignited the fuse? Not that much, but enough to push the 10-year US Treasury yield down from 4.15% on 30 July to 3.79% on 2 August, even testing 3.66% during the session on 5 August - a fall of almost 50 basis points at the best in less than a week!
The major events included :
the rate hike in Japan,
the Fed's accommodative signal and, above all,
the US employment report.
The latter, which came in below expectations, was impacted by a one-off weather factor that the markets chose to ignore. They preferred to focus on the half-empty glass and see the risk of a recession, fearing that the Fed had waited too long before cutting rates and would have to work twice as hard.
The 2-year Treasury yield followed the same path, from 4.36% to 3.88% over the same period, and 3.65% during the session on 5 August – a fall of 70 basis points at the best in less than a week.
The trajectory of this indicator of monetary policy expectations leaves no room for doubt, as does that of the 10-year maturity, which is more reflective of economic expectations:
In other words, this movement in the curve reflects expectations of accelerated rate cuts against a backdrop of anticipated recession.
During the session on 5 August, the curve even briefly normalised and its slope became positive again for the first time since July 2022 - the longest it had ever remained inverted.
Volatility exploded and, during this session of 5 August, the movement of the VIX index broke its amplitude record since its creation in 1990.
From two 25 basis points rate cuts by the end of the year, the market began to anticipate rate cuts even before the next meeting in September!
The Fed rightly pointed out that this employment report did not yet indicate a recession and that it could wait for other economic data before its September meeting.
Combined with the rather reassuring figures published at the start of the week, these comments helped to correct the extreme movements.
Between 5 and 8 August, the yield of the 10-year maturity rose to 3.97%, but expectations of rate cuts remain high.
What can we learn from these movements and what lessons can we draw from them?
In the short term, the extreme movements will continue to deflate. However, the bond market will continue to be on a roll: it is benefiting from
the economic slowdown,
the rate cut cycle that is taking shape and also
from falling inflation.
During this period of intense stress, high quality bonds played their role as a shock absorber. And against a backdrop of economic slowdown and more accommodative monetary policies, high quality bonds remain an essential asset in any diversified portfolio.
