Calm Before the Storm: Long Bond Yields Defy Uncertainty

The U.S. Treasury market is displaying an unusual calm, with long-dated yields defying economic uncertainty and geopolitical tensions. The 30-year 'long bond' yield has reached 6-week lows of 4.31%, flattening the 2-30 year U.S. yield curve gap to just 16 basis points – its lowest since August. Meanwhile, French bond yields have fallen to 2-month lows, and the French-German spread has compressed to two-week lows around 74bps, indicating a rally in French bonds and stocks.

Long-dated Treasury yields are often seen as a barometer of investor sentiment and economic expectations. Their recent drop suggests that investors are seeking safer havens and lower-risk assets, as they expect economic growth to slow or remain sluggish. This flattening of the yield curve signals economic uncertainty and investor caution, as longer-term yields are more sensitive to future economic prospects.

The calming of the Treasury market, despite economic and trade uncertainty, is notable. Money market fund holdings have been rising, reaching a record $6.77 trillion, which could be contributing to the calming of the U.S. Treasury market. This surge in cash-like investments might be indicative of investor caution and a preference for safer assets, potentially influencing the demand for and supply of government bonds.

International political tensions, such as those in France and South Korea, can also influence the U.S. Treasury market through risk appetite and safe-haven seeking. When political uncertainty rises, investors often flee riskier assets for the safety of U.S. Treasuries, driving up demand and pushing yields down. The recent drop in long-dated yields may be attributed to the French pension reform protests and South Korean political turmoil, as investors seek safer investments.

The European Central Bank (ECB) is expected to cut rates next week, which could impact U.S. Treasury yields through spillover effects. When the ECB cuts rates, it can lower the cost of borrowing for businesses and consumers, potentially stimulating economic activity. This can lead to higher inflation expectations, which can boost long bond yields. However, the ECB's rate cut can also make U.S. Treasury bonds more attractive to foreign investors, as they offer higher yields than European bonds. This increased demand for U.S. Treasury bonds can push up their prices and lower their yields. The net effect of the ECB's rate cut on U.S. long bond yields will depend on the relative strength of these two opposing forces.



As we approach the November payrolls report, investors are bracing for potential headwinds. The report is expected to show payrolls increased by 200,000 jobs in November, but there remain nagging doubts about the labor market after October's surprisingly small 12,000 gain. The unemployment rate is expected to tick up a tenth to 4.2%. While October's low jobs reading was distorted by storms and strikes, this week's U.S. economic updates have nodded to some emerging softness, most notably in the ISM survey of the dominant service sector but also in creeping jobless claims, ebbing hiring rates, and sub-forecast private payrolls.



The U.S. economic surprise index compiled by Citi remains firmly in positive territory but at its lowest since October. Ahead of the jobs report, Fed futures remain uncertain about another rate cut this month and price just a 65% chance of a move. Fed Chair Jerome Powell on Wednesday appeared to signal a slower pace of rate cuts ahead when he said the economy was stronger at this point than the Fed had expected in September.

In conclusion, the calm in the U.S. Treasury market, despite economic and political uncertainties, is an intriguing development. Investors seem to be positioning themselves for potential headwinds, with a preference for safer assets and lower-risk investments. As we approach the November payrolls report, the market's focus will shift to the labor market data and any hints from the Federal Reserve about future monetary policy.