What’s New

When reflecting on the month of October, there’s no question that the defining feature of markets was the sustained rise in Treasury yields.

One logical question to ask, then, is why? Why is it that yields rose, and what might it mean moving forward? The answer to this question could have important implications for financial markets in the coming months.

The most popular answer to that question has been presidential candidate Donald Trump’s surge in the polls. We saw the move higher in the yields roughly coincided with his inflection higher across various polls in late September. A closer look suggests other factors may be at play. Consider that the options markets are still suggestive of a significant move in yields one way or the other after the election. From this, we can potentially infer that no candidate’s victory is effectively priced into the bond market.

If not politics, though, then what could be driving the move higher in yields? Perhaps it has something to do with ongoing concerns about the state of public finances in the US. After all, while households and corporations termed their debt out post-COVID as rates went to zero, the Treasury chose to use shorter-term financing. Now, with over 50% of outstanding debt having to be rolled over in the next three years, and both parties showing a preference to increase deficits when in power, concerns about the fiscal sustainability of the US have moved to the fore. Yet this, too, may fall short. It’s hard to imagine there being a shortage of buyers for US Treasuries, and everything is relative. Does the US really look so much worse than, say, Italy, France, Japan, or China? The answer is no.

So, what does that leave us with? Growth and inflation. Or, stated differently, reflation.

In looking at the backup in long-term yields from their local bottom on September 16th, they coincided nearly to the day with the start of the backup in inflation breakevens. In fact, decomposing the rise in yields, the bulk of the move can be attributed one-for-one to the rise in long-term inflation expectations as priced by the bond market. Similarly, the rise in yields also happened alongside evidence of a still-resilient economy. Though an imperfect indicator, yields followed the Atlanta Fed’s GDP Now model higher through September and into October as the market priced out a recessionary outcome. None of this is to say that politics aren’t moving yields. The same for fiscal concerns. But it’s entirely possible that the real drive of the move higher in yields is more about the economy than anything else.

Our Perspective

Of course, a reflationary environment is only one potential path forward, and things need not play out in that way.

Could election uncertainty weigh on markets and confidence, sending markets and the economy into a period of weakness? Potentially.

Could reflation take hold and eventually fuel a no-landing scenario? Maybe.

There are any number of potential paths forward. In an uncertain environment, we continue to believe that investors should be prepared for volatility in markets. We believe that our active approach to investment management will continue to allow us to uncover investment opportunities even in volatile markets, while largely avoiding parts of the market where we see elevated risks moving forward.

Reflationary Pressures: An Economic Shift?

For more of our views on reflation, read our latest article where we discuss the three trends are influencing a shift to reflationary pressures after two years of disinflationary ones.

Our View

Economic Cycle		The US economy has remained resilient despite the aggressive hiking cycle we saw from the Federal Reserve. However, we did see pain in industries including transport and manufacturing. The US consumer has remained strong. We believe that the lagged effect of monetary policy could start to be felt in other parts of the economy in the coming quarters, and we are keeping a close eye on the labor market.
Stock Market		The US stock market continues to trade near all-time highs. Sentiment now appears stretched and valuations are not compelling. To date, market returns have been driven by multiple expansion. EBIT margins climbed to historical highs in the years following COVID lockdowns; elevated input costs and weakening demand and pricing power are posing a risk to the ability of corporations to maintain earnings at their projected level. Returns will be harder to come by and stock selection will be increasingly important.
Bond Market		While growth has remained resilient and inflation remains above target, interest rates have come in off of their peak as the market has started pricing in rate cuts from the Fed. Corporate spreads remain well contained, particularly considering the risks we see to the economy.
Important Issues on the Radar		Inflation: After surprising to the upside to start the year, inflation has resumed its downward trajectory. However, we would caution that we are still well above target and upside risks remain.
		China’s Economy: China has pivoted on key economic issues that acted as severe headwinds to growth over the last two years; however, economic growth appears to be stagnating and it will be critical to monitor the magnitude and the effectiveness of the policy response in the coming months.

Indicates change Indicates no change

Source: Bloomberg.

All investments contain risk and may lose value. This material contains the opinions of Manning & Napier, which are subject to change based on evolving market and economic conditions. This material has been distributed for informational purposes only and should not be considered as investment advice or a recommendation of any particular security, strategy or investment product. Information contained herein has been obtained from sources believed to be reliable, but not guaranteed.

This newsletter may contain factual business information concerning Manning & Napier, Inc. and is not intended for the use of investors or potential investors in Manning & Napier, Inc. It is not an offer to sell securities and it is not soliciting an offer to buy any securities of Manning & Napier, Inc.