Recession Fears Rising! Soft bond auction and weak job reports spark investor panic—Is your portfolio ready?

On Wednesday, major U.S. equity averages closed lower, failing to sustain a rebound through to a second straight session. Investor sentiment was notably impacted by a soft $42 billion bond market auction, which revealed underlying concerns about the economic outlook.

Disappointing Bond Auction

The U.S. stock markets started to decelerate following a lackluster $42 billion 10-year note auction. The bid-to-cover ratio, a measure of demand, dropped to 2.32 from 2.58 in the previous auction. This decline indicated weaker investor interest in the bondsUnited States Treasury securities are debt instruments issued by the United States government to finance its spending. Treasury securities come in a variety of forms, including bil... More, causing a ripple effect in the stock markets.

Yield and Unemployment Data

Yields tumbled to more than one-year lows after the employment report for July showed an unexpected increase in the unemployment rate, coupled with job gains falling short of economists’ forecasts. This data heightened fears of an imminent recession, influencing market dynamics.

Impact of Dollar/Yen Carry Trades

Traders unwinding popular dollar/yen carry trades, where they sold the Japanese currency to buy U.S. assets, added to the demand for safe haven U.S. debt. However, as stocks began to recover, this demand ebbed, leaving Treasury yields well below their recent trading levels and diminishing interest in Wednesday’s debt auction.

Auction Results and Market Reaction

The 10-year notes sold at a high yield of 3.96%, which was 3 basis points above their pre-sale trading levels. The demand, measured by the bid-to-cover ratio of 2.32, was the weakest since December 2022. Vail Hartman, U.S. rates strategist at BMO Capital Markets, noted, “Investors just weren’t willing to pay up for sub-4% 10s,” suggesting that the market might need to adjust further before dip buyers return in a significant way.

Corporate Debt Issuance

Heavy corporate debt issuance also contributed to the rise in yields. Michael Lorizio, senior fixed income trader at Manulife Investment Management, explained, “You have a lot of issuers who paused on Monday and even maybe held back yesterday just to make sure the coast was clear in terms of how risk assets are going to be received and now are coming to market today.”

Yields on Short-Term and Long-Term Notes

Yields on interest rate-sensitive two-year notes increased by 1.8 basis points to 4.0034%, after dropping to 3.654% on Monday, the lowest since April 2023. Benchmark 10-year note yields rose by 8 basis points to 3.968%, up from 3.667% on Monday, the lowest since June 2023. The yield curve between two- and 10-year Treasury notes steepened by 4 basis points to minus 4 basis points, having reached 1.50 basis points on Monday, marking its first positive turn since July 2022.

Federal Reserve’s Potential Rate Cuts

Traders are anticipating that the Federal Reserve will cut interest rates by 50 basis points at its next policy meeting on September 17-18, as the economy shows signs of slowing. However, there is also a 31% chance of a smaller 25 basis point rate reduction, according to the CME Group’s FedWatch Tool. The likelihood of an emergency rate cut before the September meeting has decreased as risk markets have recovered.

Upcoming Economic Indicators

The next significant U.S. economic release will be the consumer price inflation data for July, scheduled for August 14. Additionally, comments from Fed Chair Jerome Powell at the Fed’s Jackson Hole Economic Policy Symposium on August 22-24 may offer further insights into the path of future rate cuts.

Geopolitical Tensions

Rising geopolitical tensions in the Middle East could also boost demand for U.S. Treasuries, as investors seek safe-haven assets amidst global uncertainty.

Looking Ahead

In summary, the major U.S. equity averages faced a decline on Wednesday, influenced by a disappointing bond auction and the ripple effects of rising yields. The complex interplay of economic data, corporate debt issuance, and geopolitical tensions continues to shape investor sentiment and market dynamics. As the Federal Reserve’s next policy meeting approaches, the markets remain on edge, anticipating potential rate cuts amidst a backdrop of economic uncertainty.