When the borrower becomes the risk
Last week ended with an open question. The Fed had slowed its pace, long-term yields had not, and the September employment report was meant to show which of the two was right. The answer looked clear. Only 29,000 jobs were added in September, against an expected 90,000, and unemployment rose to 4.2 percent. The odds of a rate increase on 28 October fell to roughly one in five.
Yet on Wednesday the US ten-year yield touched 5.36 percent, its highest level in 24 years. In Paris the ten-year yield approached 5 percent, and the gap with Germany became the widest since the euro crisis. Equities, meanwhile, set a record.
A weaker economy should have pulled government bond yields lower. It did not. This week the biggest risk in the market is no longer the central bank. It is the government that has to borrow.
The jobs report gives the Fed a reason to wait
Last Friday's report was weaker than the headline suggests. The 29,000 new jobs came after downward revisions totalling 60,000 for July and August, which leave July with a loss of 10,000 jobs. Over three months, job growth now averages 51,000 a month. Wage growth slowed to 3.0 percent on the year, below the expected 3.2.
The minutes of the September meeting, published on Wednesday, showed that most participants judged another increase "would likely be appropriate by year end." Many officials warned that the longer energy stays expensive, the greater the risk that higher costs spread more broadly through the economy. On Thursday Governor Christopher Waller said in Istanbul that there is "some flexibility" on timing, and that increases need not come at consecutive meetings.
The market took that literally. According to CME FedWatch, the probability of an October hike is now around 19 percent, down from roughly 70 percent at the end of September. The probability of at least one increase by year end, however, stands at 84 percent. The Fed is postponing. It is not standing down.
Long-term yields reach a new peak
A weak labour market and a patient Fed should have pushed long-term yields down. The opposite happened. Right after the jobs report the ten-year yield dipped to 5.16 percent, but it closed Friday at 5.28. Monday brought 5.31 percent, and on Wednesday it touched 5.36 percent intraday, the highest since 2002. The thirty-year yield climbed to around 5.70 percent.
Several worries met that Wednesday. Brent rose back above 100 dollars, a hurricane approached the Gulf of Mexico, and reports that SpaceX sought around 40 billion dollars in financing fed concern that companies and the government are competing for the same money. Goldman Sachs estimates AI-related bond issuance this year at 489 billion dollars already. A strong auction of 39 billion dollars in ten-year notes calmed things the same afternoon.
On Friday the ten-year closed at 5.24 percent and the thirty-year at 5.60, both slightly lower than a week earlier. The two-year ended at 4.80 percent. The gap between two and ten years remains around 45 basis points. Investors want extra compensation to lend for a long time, whatever the Fed decides. The risk no longer sits in the next rate decision. It sits in the maturity.
Equities look past the yields
The S&P 500 set a record on Tuesday and ended the week at 7,811.54, a gain of 1.2 percent. The Dow rose 0.9 percent to 51,654.95 and the Nasdaq 0.6 percent, its fourth straight weekly gain. The VIX, the gauge of expected volatility, fell to 14.84.
Below the surface the picture was less calm. The Russell 2000, the index of smaller companies, lost 0.9 percent. Those are precisely the firms that depend on credit, and credit did not get cheaper this week. On Thursday technology stocks took a hit after the Financial Times reported that OpenAI had told investors of annualised revenue of nearly 50 billion dollars, well below the 70 billion that had circulated earlier.
Large companies with their own cash flows carry the index. Companies that need to borrow pay the bill. A record that rests on a narrow group is not a broad recovery.
France borrows at a higher cost than Italy
In Europe, inflation rose faster than expected in September. Last Friday Eurostat published a flash estimate of 3.8 percent, against an expected 3.6 and 3.2 in August. Energy was 18.8 percent more expensive than a year earlier. Core inflation, excluding energy and food, rose only slightly to 2.5 percent. Dutch inflation came in at 3.0 percent.
The same day the gap between French and German ten-year yields widened to almost 147 basis points, the widest since 2012. The French yield approached 5 percent, the highest since 2002, and France now pays more to borrow than Italy and Greece. Prime Minister Lecornu has no majority, and on Tuesday parliament begins debating a budget with 54 billion euros in savings. After a recovery the spread closed Friday at 132 basis points. The euro fell to 1.116 dollars on Monday, its lowest in seventeen months.
The ECB is keeping its options open. Christine Lagarde signalled that the rise in long-term rates is already slowing growth on its own. In a Reuters poll, 70 of 73 economists expect the deposit rate to stay at 2.50 percent on 29 October, and 64 expect an increase in December. The ECB can support France, but only on conditions. The market is already testing them.
Oil climbs on the Gulf, gold finds support
On Sunday 4 October OPEC+ left its production targets for November unchanged. On Monday Brent still fell to 100.32 dollars, after the G7 announced the release of up to 100 million barrels of crude and diesel from emergency stocks. Then the picture turned. In the week to 5 October at least twelve ships were attacked in and around the Strait of Hormuz, the highest number since the war began, and flows fell to around 8.5 million barrels a day, some 40 percent below normal. Hurricane Isaias shut in up to 72 percent of oil output in the US Gulf of Mexico. Brent rose around 4 percent on Thursday.
Friday brought some relief. President Trump said the United States will not attack Iran before the midterm elections on 3 November, and Washington temporarily allowed imports of Russian diesel. Brent closed at 104.72 dollars, up 2.4 percent on the week, and WTI at 91.85. The weekend brought fresh unrest: a supertanker struck a sea mine on Saturday night, another tanker was hit on Sunday, and a Houthi strike on Saudi Arabia killed twelve people according to Reuters, among them an American.
Gold gained 1.3 percent to around 4,194 dollars an ounce, while the dollar index rose for a fourth straight week to around 102.2. A strong dollar normally weighs on gold. This week investors looked for an asset that depends on no government at all.
Where this leaves the markets
On Monday the US bond market is closed for Columbus Day. On Tuesday the big banks open the earnings season and the budget debate begins in Paris. On Wednesday 14 October the September US inflation report follows, the last major figure before the Fed decision on 28 October. A high reading could quickly bring the odds of an October hike back.
The ECB decides a day after the Fed, and the US elections follow on 3 November. In Hormuz, hardly anyone expects a breakthrough before that date.
Two weeks ago good news cost money. Last week the yardstick moved. This week showed that bad news about the economy no longer pulls long-term yields down, in Washington or in Paris. Investors are no longer watching only what central banks do. They are watching who is borrowing. The rate decision has been postponed. The borrower's risk has not.
