Mr. Bond back at Centre Stage!

The North American markets continued to witness choppy trading over the course of August. The hopes of a truce between Iran and the United States, the Federal Reserve keeping the policy rates unchanged during the Federal Open Market Committee (FOMC) meeting on 29th July, and better-than-expected corporate earnings during the second-quarter earnings season, particularly of the Artificial Intelligence infrastructure providers, helped the investor enthusiasm during the first half of the month. However, investor concerns resurfaced during the second half of the month after hostilities between the United States and Iran escalated again and crude oil prices jumped. West Texas Intermediate (WTI) Crude Oil dropped from ~$85/barrel to ~$75/barrel during the first week of the August but climbed back to ~$85/barrel by the end of the month. As of this writing, the WTI crude oil was trading at ~$102/barrel.

The Fed chair, Kevin Warsh, announced intentions of removing forward guidance from the Fed’s communication have added to the uncertainty in the fixed income markets in an already fragile set-up. The news that the United States’ total debt has gone beyond $40 trillion while government spending is rising and inflation remains persistent has made the investor anxiety palpable in the fixed incomes markets. In addition, the extraordinary levels of capital expenditures to build the artificial intelligence infrastructure has also had companies borrowing at an unprecedented pace from the markets. This corporate issuance is competing with the government borrowing at a time when the United States total debt is at record highs, government expenditure is rising, and disruption in oil supplies from the middle east is keeping up the inflationary pressures. Consequently, the bond yields and expectations of a policy rate hike have risen, and market participants are now expecting one rate hike in September and another in December (See Figure 1).

 Figure 1: Implied Policy rates and # of hikes

Source: Bloomberg

Scott Bessent, the United States treasury secretary has maintained an appearance of control, however, markets have sensed the growing unease with high bond yields. His market interventions to help the depreciating Japanese Yen (to reduce the likelihood of Japan selling US treasuries to support Japanese Yen and thus further spike the bond yields) and the “Treasury Twist” plan where treasury buys long-term debt from the proceeds of sale of short-term debt to push down long term yields have left enough breadcrumbs for the fixed-income investors to deduce that the trajectory and pace of rising bond yields (See Figure 2) are making the administration uncomfortable, in our opinion.  

Figure 2: United States Government Bond Yields

Source: Bloomberg

The Fed Chair’s detailed comments at the annual Jackson Hole symposium were seen as an attempt to contain the damage as he explained the datapoints he looks at to form his views that guide the policy and reemphasized the focus on inflation. This provided some respite from the growing chatter on Fed’s reaction function and credibility. However, we note that the United State’s President has again asked for reduction in policy rates in the recent weeks. This puts the market expectations from the Federal Reserve at odds with the wishes of the United State’s president. If the Federal Reserve chooses to not hike policy rate in the September meeting, we think the chatter on Fed’s credibility and independence will come back to fore. Thus far, as evident from the bond yields movement, the attempts from Fed and Treasury Secretary to assuage the fixed income market investors have failed, suggesting that market participants are expecting more than just talk or signals that telegraph intentions.

The Bank of Canada held the policy rates in place despite rising inflation concerns owing to the uncertainty from new tariffs and trade negotiations with the United States. The trade uncertainty should continue to weigh on the Canadian economic growth and outlook in the short-term, however, we think the commodities heavy Canadian Index should find support from higher oil prices and potentially higher gold prices, if the USD debasement theme gathers pace again. Corporate earnings have provided an offset to the headwinds posed by rising bond yields, geopolitical tensions and adverse macroeconomic developments thus far. We think the market environment might remain choppy in the near-term underpinned by ebb and flow of news around these topics on top of the politically charged atmosphere until the mid-term elections in the United States.

Source: Bloomberg

Vipul Arora is a Portfolio Manager with CI Assante Wealth Management Ltd. The opinions

expressed are those of the author and not necessarily those of CI Assante Wealth

Management Ltd. Please contact him at 613-258-1997 or visit ofarrellwealth.com to discuss

your circumstances prior to acting on the information above. CI Assante Wealth Management Ltd. is a member of the Canadian Investor Protection Fund and the Canadian Investment Regulatory Organization. Insurance products and services are provided through Assante Estate and Insurance Services Inc