Crash And Bond: The Selloff In Long-Term Treasuries Has Reached Epic Proportions

What happened last week?

US

• The International Monetary Fund (IMF) boosted its global inflation forecast for next year.
• US inflation held disappointingly steady in September, despite hopes it might edge lower.
• The crash in long-term Treasuries reached dot-com proportions.

Europe, Middle East, and Africa

• French luxury conglomerate LVMH reported a bigger-than-expected slowdown in sales growth.
• Oil prices jumped because of renewed instability in the Middle East.

Asia

• Travel and spending over China’s Golden Week holiday were surprisingly low.

What does all this mean?

The IMF boosted its global inflation forecast for next year – to 5.8% from the 5.2% predicted three months ago – and said it sees consumer price increases lingering well above central bank targets in most countries until 2025. What’s more, the institution now sees global growth of just 2.9% for next year, down slightly from its earlier outlook, and below the 3.8% average of the two decades before the pandemic. The US was one of the few countries where the IMF upgraded its growth prediction, thanks to resilient consumer spending in the world’s biggest economy.

Sticking to the US, consumer prices rose by 3.7% in September, matching the annual pace set in August and defying expectations for a slim slowdown to 3.6%. The news underscores how a strong labor market is continuing to boost consumer spending and keep price pressures elevated. Core inflation, which strips out volatile food and energy prices, came in at 4.1% – in line with economist estimates and down from August’s 4.3%. Following the data’s release, traders modestly increased bets that the Federal Reserve (the Fed) would hike rates again before year-end, though the odds are still around 50/50.

The Fed’s most aggressive rate-hiking run in decades has resulted in huge losses in the Treasury market over the past two years. US government bonds with maturities of ten years or longer, which are highly sensitive to changing interest rates, have now declined by a stunning 46% since their peak in March 2020. That’s just shy of the 49% drop in US stocks following the burst of the dot-com bubble at the start of the century.

China, which drove the luxury industry’s record-breaking sales since 2020, relaxed its pandemic restrictions this year. But economic troubles dampened consumer confidence, leading high-end goods conglomerate LVMH to report a nasty sales slowdown in Asia (excluding Japan). And because that’s LVMH’s prime market, the firm’s overall revenue grew just 9% last quarter from the same time last year – roughly half the pace notched in the first half of the year.

Oil prices have been climbing since the summer on the back of dwindling stockpiles and supply cuts from Russia and Saudi Arabia. And after taking a little breather at the start of the month, oil prices jumped again last week with renewed instability in the Middle East, which accounts for nearly one-third of the world's oil supply. Although geopolitical events usually cause only temporary shifts in oil prices, today’s low global oil inventories mean that any potential supply disruptions could have an outsized effect on the market.

China’s Golden Week holiday was supposed to showcase the country’s long-awaited recovery, with revelers splashing enough cash to give the world’s second-biggest economy a much-needed boost. Just over 800 million domestic trips were made over the eight-day vacation, bringing in $103 billion in domestic tourism revenue. That landed short of official projections and was only a tiny bit better than the pre-pandemic total in 2019 – despite this year’s celebrations lasting a day longer. That’s a sign that China’s economy as a whole is still far from fighting fit.

This week’s focus: US government bonds

Long-dated US Treasuries are in the grips of an epic crash. At 46%, their current losses are twice that of their next biggest decline, which happened some 42 years ago, when an earlier battle with inflation saw the Fed pushing ten-year yields above 15%. (Remember, bond prices fall as their yields rise.) The drop in Treasuries today is also far steeper than the average 39% fall seen in all US stock bear markets since the 1970s, and easily surpasses the 25% slip in the S&P 500 last year when the Fed started hiking interest rates from near zero to more than 5% today.

And this whole episode might cause you to think slightly differently about US government bonds: because while they’re rightly considered to be among the world’s safest assets, the ones with longer maturities can be volatile and prone to massive drawdowns. It’s worth bearing in mind that the longer the maturity of the security, the greater its sensitivity to interest rate changes. Longer-dated bonds are the ones you want to own when rates are falling, but they take a beating when interest rates are rising rapidly. Of course, there is a silver lining in the Treasury market: while the prices of existing bonds are dropping because of today’s climbing rates, newly issued bonds with higher yields are offering long-term investors the chance to grab bigger returns over time.

The week ahead

• Monday: Eurozone trade balance (August).
• Tuesday: UK labor market report (September), US retail sales (September) and industrial production (September). Earnings: Bank of America, Goldman Sachs, Johnson & Johnson.
• Wednesday: China economic growth (Q3) and retail sales (September), UK inflation (September). Earnings: Morgan Stanley, Procter & Gamble, Netflix, Tesla.
• Thursday: Japan trade balance (September), US existing home sales (September). Earnings: AT&T, Blackstone, TSMC, Philip Morris International.
• Friday: Chinese central bank one-year loan prime rate announcement, Japan inflation (September), UK retail sales (September). Earnings: American Express