Will the Booming Economy Break the Markets?

By Charles Tan & John Lovito - October 5, 2018

Good news on the economic front sometimes translates to bad performance in the financial markets—at least in the short term.

We saw this dynamic play out in February, when strong wage growth and other economic gains caused U.S. Treasury yields to spike and U.S. stock prices to plunge. Once investors digested the data, though, stocks quickly recovered.

We’re seeing a similar scenario unfold today, as Treasury yields approach multi-year highs.

Growth Remains on a Roll

The first week of the fourth quarter was full of upbeat economic news, including:

  • The U.S. sealed a new trade deal with Canada and Mexico, replacing the 24-year-old North American Free Trade Agreement (NAFTA) with the U.S. Mexico Canada Agreement (USMCA).
  • ADP reported that private companies added 230,000 jobs in September, up 62,000 from August.
  • The U.S. services sector expanded at its fastest pace ever in September, according to the Institute for Supply Management. 
  • Despite effects from Hurricane Florence, the U.S. unemployment rate fell to 3.7% in September, its lowest level in nearly 50 years. 
  • The September gain in average hourly earnings—8 cents—brought year-over-year wage growth to 2.8%, in line with market expectations.

In response to this robust data, the yield on the 10-year Treasury note, a key benchmark lending rate, soared to multi-year highs (bond prices decline as yields rise). As of Friday, Oct. 5, the 10-year Treasury yield was 3.23%, up from 3.06% just a week earlier.

As Treasury yields soared, stock prices struggled. The rapid rise in Treasury yields, combined with the Federal Reserve’s (Fed’s) ongoing rate-hike campaign, led to concerns that sustained higher rates may trigger a slowdown in the economy.

Data Verify Fed’s Outlook

We believe such fears are unfounded in the near term, and the data released this week only confirm what the Fed has been stating—that the U.S. economy remains on firm footing. Furthermore, we don’t expect the Fed to deviate from its stated course based on this week’s economic reports.

Although we expect Treasury yields to eventually consolidate near current levels, we also believe there is potential for an overshoot in the short-term. From a technical perspective, a combination of waning reinvestment from the Fed (due to its balance sheet cuts) and a meaningful increase in upcoming Treasury issuance should keep U.S. rates under pressure, as long as the economic data remain robust. Meanwhile, the credit markets have generally remained stable, reflecting an environment of still-solid corporate credit fundamentals.

On the macroeconomic front, the recent announcement of the “new NAFTA” shows the U.S. government’s willingness to compromise. The resulting de-escalation of protectionism should reduce the risks to global growth, a factor mainly reflected in higher longer-maturity yields.

Charles Tan
Charles Tan
Co-CIO, Global Fixed Income
John Lovito
John Lovito
Co-CIO, Global Fixed Income

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The opinions expressed are those of American Century Investments (or the portfolio manager) and are no guarantee of the future performance of any American Century Investments' portfolio. This material has been prepared for educational purposes only. It is not intended to provide, and should not be relied upon for, investment, accounting, legal or tax advice.