During election years, there is always considerable discussion of a potential “October surprise” – meaning a major event that happens in the month before the election that has the potential to sway the vote. If that same term were used for markets specifically, perhaps the largest October surprise for investors has been the rapid rise in interest rates.

The US 10 year interest rate was 3.8% as of September 30, 2024. In just three weeks, it has spiked back on to 4.24% without evidence of a clear catalyst – with 25 basis points of that rise coming in just the past five trading days.

What’s behind the move? As is always the case, there are a variety of theories for this move in rates including:

*Stubborn inflation – September’s CPI print may have caused market participants to question the narrative that inflation has been conquered and will continue to fall. If inflation stays higher, rates will stay higher and the Federal Reserve could slow rate cuts

*Stronger than expected growth – This is perhaps the strongest argument to be made for rising rates, despite the Fed’s supposed rate cutting path. Growth expectations have surprised on the upside. In a year when a recession was anticipated, growth is now running well over 3% (Atlanta’s GDPnow model projecting Q3 2024’s growth at 3.4%)

Election predictions – Improved poll numbers for President Trump this week have led to an uptick in betting market odds of the probability of a republican sweep of all houses (odds rose from 28% to 49% this week) that seems to be playing out in certain market trades. Spending tends to increase if one party controls all branches of government (as there is no opposing force asking for negotiations or concessions). Under republican government, there will also likely not be offsetting tax increases. All of this leads to more borrowing to fund US spending, causing rates to rise as supply of bonds increases

Deficits in focus – Even if we end up with a dividend government, both presidential candidates have aggressive spending plans which will lead to increases in the US debt (very challenging to offset with increased taxation). Markets could be worried about the ongoing deficit (which would increase debt supply as noted above) – even with a divided government it’s likely spending and deficits will continue

Rebalancing – Fixed income did very well in Q3 2024 as rates fell on the Fed’s rate cutting commencement. It’s possible that investors are lightening up on fixed income after those positive returns, thereby increasing supply of bonds and lowering rates.

What’s the main driver? Our thought is the rise in rates is likely a combination of all these items in addition to the general level of uncertainty regarding the upcoming election cycle.

Despite the rise in rates, we continue to see a roll for fixed income securities, even with the rate increase, as the current level of yields and the likely rate path (at the shorter durations that we prefer) remain constructive.

Never a dull moment – especially in October!

Onward we go,

Along with the latest measure of economic growth, investors will also get the September print of the Fed’s preferred inflation gauge next Thursday, Oct. 31. An October jobs report complicated by hurricanes and labor actions will follow on Nov. 1.