When we embark on a journey searching for the truth, we must always start from the assumption that we are not sure we can find it. Let us arm ourselves and set out, then, but with caution and with our feet firmly planted on the ground, remembering that our purpose is to "guess how the current economic context could bend in the face of the next American elections and what will be the size of the impact between the financial markets and the name of the next President[1]”.
Well. You have to start somewhere. I’ll start by putting one of the pole stars of the financial markets under the magnifying glass: the 10-year Treasury bond. I’ll go back to the beginning of 2023, when inflation was floating at 6.4%, and the 10-year Treasury yielded 3.74%. At the beginning of this year, inflation was at 3.94%, but how much was our dear 10-year Treasury yielding? 3.92%. Something doesn’t add up, as bond yields, which move in the opposite direction to the price, have risen significantly since mid-July. The general narrative that has been looking for the link between the 10-year Treasury yield and the trend in inflation believes it has found the explanation for this phenomenon by referring to a trio of aces composed as follows:
The issuance of US debt is increasing: let us remember that on July 31, the US Treasury turned the market upside down when it announced that it would issue more debt than expected. Now, the aim is to pocket 1.007 trillion dollars net through the sale of bonds in the third quarter: this figure represents about 25% more than what was estimated just a few months ago.
Despite being subjected to various checks, the US economy still demonstrates excellent health: consumer spending is robust, and hiring continues.
A higher inflation premium. Those who make the bond market their hunting ground would not be convinced that inflation has taken a downward slope and would, therefore, demand more excellent protection when it comes to obtaining long-term returns.
Symbiotic with this kind of fear, there would also be a twin fear, namely that bond investors have sensed that the Fed no longer intends to use “nuclear weapons[2]” against inflation since these investors do not believe that inflation is an enemy against which it is legitimate to lower one's guard, they arm themselves with nerve and ask for a higher risk premium. Although this trio of aces has the credibility brought by essential rationality on its side, I prefer to support the explanation regarding the yield of the ten-year Treasury by bringing to your attention a simple word: JAPAN. When the Bank of Japan raised the maximum limit of bond yields from 0.5% to 1%, the global bond scenario changed, and we all began to ask ourselves when we would go from 1% to 1.5% and then to 2% but above all we began to ask ourselves. "How long will it take for Japanese investors, being able to count on higher domestic yields, before they can bring their money back home?"
Let’s unpack all these questions and much more below …