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Whither Bonds?

Updated: Oct 6, 2023

Yields on the 10 year and 30 year increase as US Government obligations go on sale

The bloom is off the rose
Wither bonds?

The 10-year yield is up .3%, and the 30-year yield is up .4% since the end of the past quarter. Yields and prices move inversely, so this would mean that the value of these benchmark government obligations is falling. Why would this be?

Two hypotheses: the first, the bond market is losing confidence in the US Government's willingness or ability to honor its sovereign obligations. This we shouldn't disregard out of hand, but can say is very unlikely. No government or other Federal official has suggested default, or that, say, tax receipts just aren't where they need to be to keep the lights on in Washington, DC.

The second hypothesis is that the bond market anticipates an increase in the supply of these obligations, or a decrease in demand for these obligations, or some mixture of both. From less than two weeks away from the US general election, it looks like odds are that the Democratic party will take not only the White House, but also the Senate while retaining the House of Representatives, giving them full control of the political branches of government. They're running on a platform of fiscal expansion, which would have to be funded by tax receipts, but more likely government borrowing. More government borrowing means more stock of government debt, and an increase in stock without a commensurate increase in demand causes the price of stock to fall.

Investors tend to demand more obligations of the Federal Government when the value of risk assets decrease or are expected to decrease. This is why they are considered safe haven assets. Conversely, they fall when risk assets increase in value or are expected to increase in value. Fiscal expansion would be supportive of the value of risk assets, and so it would appear that the market thinks that not only will the Democrats control Washington in January, but this control will be good for the economy. It also could be that they believe that there will be greater economic stability, which tends to be supportive of risk-taking behavior.

In looking at the VIX, often (and inaccurately) referred to as Wall Street's "Fear Gauge"*, it would appear from its loss in value that markets are expecting less price volatility, which would imply more economic placidity. This would be confirmation of the expectation of greater predictability, if not necessarily an increase in risk appetite.

The market isn't always right about who will win elections (cf. "US General Election, 2016"), but this market action, in addition to the increase in the value of commodities in general, would signify that the market has priced in additional stimulus and additional borrowing. In twelve days we'll see if its right.

*The VIX, or CBOE Volatility Index (VIX), is an index that tracks implied volatilities of S&P 500 options contracts that trade on the Chicago Board Options Exchange (CBOE). It represents the market's expectation of 30-day forward-looking volatility. This means that it is an index that measures uncertainty, rather than fear. Interesting how no one ever calls it Wall Street's "Greed Gauge", as that would be just as accurate a description.

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