I’ve written about trend lines in the past – reminding you (and myself) that (a) no trend line lasts forever and (b) they move in both directions.
This week was yet another example of this fact as interest rates made a sharp reversal and started moving down just as rapidly as they had gone up for the past three weeks. (In case you missed it, the US 10 year touched 4.92% on Monday 10/30 and sits at 4.66% as I write this on Thursday 11/2)
Why the sudden reversal? It’s never easy to fully dissect and interpret markets and their movements, but there were three main events this week that are most likely key drivers of the positive moves for fixed income and equity investors alike.
Treasury Refunding Plan
It wasn’t so long ago that the Treasury refunding announcements went completely unnoticed by most market participants. Those days are now gone as markets focused squarely on the Treasury’s announcement on Wednesday of this past week.
The refunding plan lays out how the Treasury plans to borrow in order to raise cash to fund the growing US deficit. The latest announcement was viewed favorably by the market for a few reasons. First, the total borrowed ($112 billion) was below expectations, indicating lower supply of debt issued. Second (and most importantly), the Treasury chose to focus on borrowings of shorter duration, lowering both the 10-year and 30-year bonds issuances by $1 billion each from the last plan revealed in August. This results in a lower supply at those maturities and therefore led to rates declining (supply down, demand steady = lower rates). Third, it gave evidence that the Treasury sees rates coming down moving forward (as they opted to focus on shorter maturities. If they felt rates would rise, they would have lent longer term to lock in lower rates for longer). All of this added up to another positive indicator for markets regarding interest rates, and rates fell on the news (leading to increases in bonds and stocks alike).
Another Fed Pause
The Federal Reserve announced it’s November rate decision on Wednesday, unanimously voting to hold rates steady. Chairman Jerome Powell once again made it clear that the Fed is proceeding with caution as it comes to future rate hikes but was careful not to commit to no increases in the future.
Powell repeatedly stressed the decline in inflation and the stability of the labor market and did not focus on consumer spending or underlying strength in the economy. Many interpreted this to mean the Fed is done with rate hikes and noted how Powell appeared to be more dovish (ie: in favor of easing monetary policy moving forward)
Powell also noted that the rise in rates since the last meeting (some of which has been unwound in recent days) as well as the Fed’s quantitative tightening have further tightened monetary conditions, although the lag effects remain “long and variable.” He noted that a period of lower growth would likely be needed for inflation to return to the Fed’ 2% target but said the Fed is carefully following the data to see if policy is already restrictive enough to achieve that slowdown (the often talked about soft landing). Powell emphasized that the public’s expectations of inflation have come down meaningfully, stating “the public does believe that inflation will get back down to 2% over time, and it will. They are right.”
The Fed clearly continues to carefully balance raising rates too much (to push the US into a recession) and not raising enough/cutting too soon and potentially allowing inflation to spike yet again. However, at this meeting, the belief was they’ve gone far enough for now, so rates were held steady.
Overall, markets reacted very positively to this announcement, reading between the lines to infer that future rate hikes are not very likely. As a result, rates fell across all durations of the yield curve, resulting in positive moves for stocks and bonds
Mutual Fund Tax Loss Selling Ends
Mutual funds are pooled investment vehicles that own individual securities – bonds or stocks – just like individuals. As the mutual fund managers trade during the year, the fund generates realized gains/losses, which are accumulated within the fund for distribution to the fund holders by the end of the calendar year. As is true for most individual investors, mutual funds seek to minimize their net gain position (so as not to “surprise” investors with a big tax hit). As a result, if they find themselves with a net gain as they approach year-end, they are motivated to harvest losses as an offset.
The deadline for mutual funds to complete their tax loss harvesting is October 31 (not December 31 as it is for individuals). That deadline passed this week, which has removed a lot of selling pressure in many parts of the market and sparked buying pressure as they look to redeploy sale proceeds. Lower sales and more buys help push up prices.
What Comes Next?
For the past few weeks, the data and fund flows have been pressuring rates to rise/stocks & bonds to fall – and this week, the data (and economic announcements) had the opposite effects. For better or worse, the path forward from here depends on what the data shows moving forward. By the time you read this, October jobs data will be released, giving the Fed data for one of its mandates – full employment (the other mandate being inflation/price stability). We will continue to see quarterly earnings come out in the next few weeks, followed by inflation readings for October, then November, execution of tax loss selling by individuals – and on and on it goes.
Investing is a lifelong journey, made up of challenging weeks (see last week) and positive weeks (like this one). The key is to stick around long enough to see your fair share of both, as you just never know when the trend lines will reverse and move once again in your favor.
Onward we go,
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