There’s more behind the rise in Treasury yields

0:00Hi, I'm Chris Nelson, Senior Portfolio Manager and head of Sustainable Investing at Russell Investments. This is Market Week in Review. This week the market story is really about interest rates. That narrative is being driven by four things. Last Friday's jobs report, the continued rise in Treasury yields, what we're seeing from Central Banks outside the US, and the CPI report from Friday the 11th. Taken together, investors are asking whether inflation levels are stable enough to keep rates where they are, or could it lead Central Banks to pursue them higher? Let's start by summing up the market moves of the trailing week. Equity markets have generally moved lower with higher oil prices and rising yields creating a tougher backdrop. Higher yields are particularly problematic for long-duration equities, those that are earning their evaluation, their cash flows further out in the future. But the clearest move this week was in bonds. The 10-year Treasury yield traded as high as 4.92% on Thursday. That's its highest entry-level since October of 2023. Oil also moved sharply higher. Brent crude futures

1:05moved above $107 a barrel on renewed fighting in the Gulf. Of course, average US gasoline prices, rose in tandem with that, and elevated energy costs are adding to inflation pressure across Europe and parts of Asia as well. But let's go back now to last Friday's jobs report, because those numbers were a meaningful to the backdrop of the yield moves and the economy this week. It was generally seen as a positive report. Non-farm payrolls came in well above expectations while unemployment held at 4.1%. It's a pretty good number. Weage growth is slightly to 3.1% year-to-year from 3.2% also steady. So the labor market looks resilient without sending a particularly troubling wage inflation signal. This in itself would lend support to holding rate steady and a nice growth outlook. But the bond market is telling us investors are not yet comfortable with the broader outlook.

2:05What the 10-year is telling us, as it climbed above 4.9, is that the move is much more than just expectations for the Fed. This rise also reflects a higher term premium, as investors demand more compensation for the uncertainty around inflation, fiscal policy, and bond market issuance. We'll of course reinforce the concern, because even if core inflation behaves, Brent above $100 raises the possibility that headline inflation remains elevated for longer. So, thinking again about that CPI number, even a relatively benign inflation report may not support or ascend long-term yields lower. A reminder that this is not just about the US story. We're seeing some of the same pressure outside the US. The European Central Bank raised rates by 25 basis points on Thursday. It's second increase this year, and markets are also pricing further bank of Japan tightening on higher energy and import costs. You can see the common thread.

3:06Central banks are balancing still resilient activity against inflation that has not fully settled. Okay, so that brings us to the CPI. Since we are recording before the August CPI report is released, by the time you see this, the number is likely out. But we can and should talk about how to interpret the result, because it is one of the most important remaining inputs before the FOMC meets on September 15th and 16th. Markets have moved fairly aggressively toward a hike with futures pricing, roughly a 70% probability of an increase next week that rose a little bit after the release of the PPI numbers on Thursday. Our strategists think that maybe too hawkish, but the CPI result will be critical to the view. So, talking about the numbers, the potential scenarios, a core CPI reading of 0.2% month over month or lower would reinforce the case for the Fed to stand back. On the other hand, a reading of 0.3% or above would make the argument for the strike higher.

4:06Meanwhile, consensus expects the headline CPI, inclusive of food and energy, to rise 0.4% in August. So, there's already some expectation that the headline number will be higher. So, we could get a hot headline, but a softer core. And we think that would focus attention on the energy shock rather than the broad re-acceleration and underlying inflation. That could be relatively reassuring for Fed policy, but still leave the bond market uneasy based on the uncertainty that I described earlier. So, recapping. The story this week started with a resilient labor market. We moved through higher oil and higher bond year olds, and this contributed to equity market weakness. And then we ended with the inflation data. And all of this is a prelude to next week's FOMC rate decision. We'll come back to you on that. Thanks for watching. We'll see you again.