Vacation is Over

Back to work after summer vacation, and facing a tough month for bonds?  September is supposed to be a cruel month for stocks, but this year it could also be difficult for bonds–primarily because of the relative optimism that emerged in August.  There was talk of an economic slowdown and thus, no fed funds rate increase in December.  The Treasury market sold off only in the midst of auctions, but then rebounded.  Record short positions also buoyed the Treasury market last month.  Many of those shorts were probably covered late last month.

If the ISM index today is any guide, market rebounds might be difficult to sustain during September.  The manufacturing index and the key new orders component were totally inconsistent with the economic slowdown thesis.  If the employment report on Friday is as strong as this index, hopes of only one more rate increase in 2018 will likely evaporate.

The report this morning was a reminder that the fundamentals–above-trend GDP growth, an exceptionally tight labor market, modestly higher inflation and a crushing pace of Treasury auctions at a time when the Fed is reducing its holdings– are not favorable to bond prices.  Add a probable 50 basis point increase in the fed funds rate by year end, and a 10-year Treasury yield above 3% in the weeks ahead appears far more likely than it did during August.

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