These past couple weeks have seen some interesting movements in the US treasury market which trickles down to the rest of the bond markets, long thought to be the more sophisticated older sibling to the stock market.
Treasury auctions of 30-year bonds saw rates at their highest levels in 20 years. Stocks responded by dropping, and rates on those newly issued bonds continued to rise in the secondary market. Subsequently, the treasury secretary announced that he would be buying back a significant amount of those same bonds to keep rates down. Long-term rates fell and the market rallied. Later in the week, however, bond rates went back up and stocks dropped again. This is the treasury dabbling in monetary policy by taking actions to try and keep rates lower than they are in the free markets (or open markets…but I can’t help myself).
At the risk of nerd-ing out, I wanted to take a moment to describe what we believe is happening, and why the long-term treasury market has such impacts on the stock market.
Treasuries represent what the US government pays to finance its liabilities, and they also act as a key reference for corporate bonds. Spreads for corporate bonds are measured against treasuries of similar maturity – the excess interest rate that companies pay is a measure of their relative risk compared to the US government.
So, when the government tries to influence interest rates, they are pushing that into the cost of borrowing for corporations, which has a direct impact on earnings and therefore stock prices (interest rates ↓ stocks ↑, interest rates ↑ stocks ↓). But as the last step shows, the treasury’s influence on interest rates is not perfect – the market’s appetite drives supply and demand and price setting to an extent that overwhelms the treasury’s wishes. This is what we mean when we say free markets.
Secondly, and maybe more importantly, the treasury’s actions today are foreshadowing. The big question on investors’ minds is – what will the treasury do to pay for its obligations going forward – and is it predictable? Will it issue long-term debt (like it just did initially) or will it issue short-term debt (like it subsequently did to finance the buybacks)? Ultimately this all leads to the question of will the interest on the debt balloon unsustainably and ultimately spell further inflation, reducing the value of US dollar? And how do markets feel about that?
The treasury secretary’s moves seem to have caused markets to wonder about policy consistency. And as we know, inflation still hangs over the economy – see tariff rebates, new tariffs, continued war and a congress that does not want to/cannot work together address this conundrum. The name of US economic policy game continues to be uncertainty, and so the market keeps one eye on the treasury, another on the fed, crosses fingers for the AI trade and heads into midterms. In all, if this all means US inflation and a weakening US dollar, then diversification again becomes crucial as we have already seen in the performance of international markets vs. the US this summer.
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