Even with a widely anticipated Federal Reserve interest rate cut this week, US Treasury bonds reflect growing anxiety about the upcoming year. Political shifts in Germany and Canada, coupled with a robust US economy, contribute to this unease.
As the Fed convenes for its final meeting of the year, futures markets confidently predict a quarter-point reduction in the policy rate. However, December surveys reveal booming growth in the US services sector, record-high stock markets, and the likelihood of future tax cuts. Consequently, market expectations suggest only two further rate cuts next year, with Fed policymakers potentially raising their estimate of long-run neutral rates above 3%. November’s retail and industrial data, due Tuesday, will further inform the Fed’s two-day deliberation.
This confluence of growth, interest rate projections, and fiscal outlook heading into 2025 has propelled 10-year Treasury yields on a 30 basis point round trip within a month. Yields have reclaimed 4.4% this week, their highest point since November 21st, and a significant climb from the December 6th lows. The 30-year “long bond” yield mirrors this trend, presenting a challenging backdrop for Tuesday’s 20-year debt sale.
10-year Treasury Constant Maturity Minus 2-Year Treasury Constant Maturity
Adding to the concern, the New York Fed’s estimate of the term premium – the extra yield investors demand for holding long-term Treasury paper – is also rising. The 10-year gauge has returned to 28 bps for the first time in over a month, suggesting anxieties surrounding fiscal policy and persistent apprehension about the Fed’s direction.
Global political developments further complicate the fiscal landscape within the G7. The unexpected resignation of Canadian Finance Minister Chrystia Freeland, less than a month before potentially significant tariff changes under a new US administration, has sent ripples through Canadian markets. The Canadian dollar and government debt yields rose on the news. Freeland cited concerns over proposed government spending increases potentially jeopardizing Canada’s ability to weather economic challenges.
Canadian Dollar to US Dollar Exchange Rate
In Europe, German Chancellor Olaf Scholz’s loss of a confidence vote points towards snap elections in February, following the collapse of his ruling coalition. This political instability, coupled with declining sentiment in the latest IFO German business surveys, has led to a dip in the euro and German bund yields. Meanwhile, France remains in political limbo despite appointing a new prime minister. Moody’s recently downgraded France’s credit rating, citing concerns about government finances.
These global uncertainties have bolstered the dollar index. The dollar/yen retreated slightly from Monday’s three-week high, but the dollar/yuan continues its upward trajectory. Economists now anticipate no change in the Bank of Japan’s interest rate at its upcoming meeting, a significant shift in sentiment.
The yuan faces continued pressure following a series of weak economic data releases and expectations of aggressive policy easing. China experienced record capital outflows in November, reaching $45.7 billion, as tracked by official cross-border payment data. While initial market reactions to last week’s Chinese government policy meeting were muted, stocks rebounded on reports of maintaining a 5% economic growth target for next year, supported by a substantial budget deficit. However, signs of potential easing of tensions between the US and China emerged this week.
In contrast, sterling strengthened after robust UK wage growth data diminished expectations of a Bank of England rate cut this week, suggesting a more hawkish monetary policy stance.
US stock futures edged lower following recent market highs. Key economic indicators, including November retail sales, industrial production, and the December NAHB housing index, along with the Federal Reserve’s policy meeting concluding on Wednesday, will provide further direction for US markets. The US Treasury’s sale of $13 billion in 20-year bonds will also be closely watched.
