In addition to monetary policy decisions from the Federal Reserve, interest rates on intermediate- and longer-dated U.S. Treasury securities are also affected by the supply coming to the market as well as the demand for existing issuances. As you can see from the chart below, even though the Fed lowered its target range for the federal funds rate by ½% to between 4¾% to 5% on September 18, the yield on the 10-Year U.S. Treasury Note has risen from 3.70% to 4.20%.
Why and what does this mean to investors?
If investors believe that the Fed was too aggressive in respect to cutting rates, fearing a rekindling inflation, they will demand a higher yield to compensate for the decrease in inflation-adjusted returns.
Since the Fed’s recent rate cut, the economic data that has been released, including the October Payroll Report, has come in stronger than expected, leading many to believe that perhaps the U.S. Economy, may not be slowing to the extent that would warrant as many cuts as previously anticipated. Investors would respond to this change in data by pushing rates higher.
Statements made by both Presidential Candidates have heightened concern over the Federal Debt. Should that concern materialize, it would lead to an additional supply of bonds coming to the market to pay for the debt incurred. Should demand remain constant, the result would be higher interest rates. Furthermore, investors may wish to be compensated for the increased risk of investing in a country with an abnormal debt to GDP ratio.
The bottom line – should interest rates continue to trend higher; they will provide a headwind to equity prices. Regarding fixed income, we will continue to ladder maturities to protect our clients from rates regardless of their direction.
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