Despite the media mileage given to it, the outcome of the US election isn’t the only game in town for investors. Equity markets have reacted to quarterly earnings while monetary policy moves are affecting the foreign exchange market. Geopolitical events continue to move commodity prices. What stands out again, though, are government bond markets – and, in particular, the rise in the term premium for the 10-year US Treasury note.
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What about the term premium?
In 2013, Ben Bernanke, the then US Federal Reserve Chairman, set the stage – decomposing the 10-year nominal rate into inflation expectations, expectations of the future path of short-term Treasury yields and the term premium.
Its economic significance is clear: The premium is the compensation that investors require for the risk that interest rates may change over the life of the bond. In other words, the premium for holding long bonds rather than just rolling over a series of short-dated bills.
The premium cannot be observed directly: it must be estimated. The result can differ depending on the method used. Whatever the method, in late October, the term premium reached a one-year high. In October 2023, the yield on the US 10-year T note had briefly exceeded 5.00%. It stood at 4.28% at the end of October 2024 after a rise by 50 basis points (bp) on the month.
So, what do the US elections have to do with this financial variable? The outcome will determine US fiscal policy in the coming years (and test the skills of the next White House occupant).
Does the latest rise in the term premium mean investors are beginning to worry about the implications of either result for the US budget deficit and the level of federal debt?
In August 2023, Fitch Ratings downgraded the US’s sovereign credit rating. When a few months later the 10-year T-note yield reached the (symbolic) threshold of 5%, some observers linked these two factors.
US Treasury Secretary Yellen said at the time that the rise in bond yields reflected the strength of the US economy rather than the burgeoning budget deficit. The decline in long-term bond yields in the weeks that followed, despite Moody’s lowering its outlook on the US rating from ‘stable’ to ‘negative’ in November 2023, tends to corroborate Yellen’s analysis.
What will happen this time?
US economy – Dynamism prevails
With the economy growing at 2.8% annualised in the third quarter as a result of a sizeable 3.7% increase in private consumption and 3.3% higher non-residential investment, domestic demand in the US is far from lacklustre.
The employment report on 1 November was therefore an unpleasant surprise. The number of jobs created in October was well below market expectations (+12 000 vs. +70 000 according to the consensus estimate plus a drop of 28 000 in the private sector). The figures for the two preceding months were also revised down – by a cumulative 112 000.
Most of the disappointment probably related to the effects of hurricanes Helene and Milton, which hit Florida in late September and early October, although the Bureau of Labor Statistics could not quantify their effects precisely.
In addition, the strike at Boeing weighed on the manufacturing sector (-44 000 jobs in the transport equipment manufacturing segment).
The unemployment rate was unchanged at 4.1% and weekly jobless pay claims returned to normal at the end of October after the weather-related disruptions to business.
The data from the Jobs Openings and Labour Turnover Survey (JOLTS) for September published ahead of the labour market report probably offer a clearer view. It describes a looser labour market than in recent years, and one that is returning to a better balance between supply and demand.
Policymakers at the US Federal Reserve (Fed) had warned that the October employment report should be treated with caution on account of the factors distorting the data. Investors did indeed choose to ignore it. At the close of trading on 1 November, the 10-year T note yield stood at 4.38%.
Don’t forget the Fed!
Two days after the election, investors will need to focus on the Fed’s next policy meeting. Markets and economists fully anticipate a cut in interest rates by 25bp – the usual size of a policy move.
Of particular interest will be Fed Chair Powell’s press conference, and how he navigates now milder market expectations of a rapid easing of policy after the Fed’s decision to cut rates by a chunky 50bp in September.
Even before the start of the easing cycle, policy rate cuts had been widely anticipated by futures markets. Any element that led investors to adjust their expectations triggered significant movements, not helped by pre-election uncertainties. With the rise in the term premium and the robust US economy, this is the third factor behind the recent rise in yields throughout the curve.
Contaminating eurozone yields
Eurozone bond market movements following those of US Treasuries is likely the only reason for the 27bp rise in the 10-year Bund yield in October. GDP growth of 0.4% in the third quarter was perhaps not as good as it looked given the one-off factors that boosted consumption, such as the Paris Olympics and Paralympics.
The contraction in investment in the main eurozone economies is arguably a fairer reflection of weaker business surveys.
According to the preliminary estimate, eurozone inflation in October exceeded market expectations at 2.0% year-on-year, up from 1.7% in September. This was due to specific, one-off factors. Core and services inflation were unchanged at, respectively, 2.7% and 3.9%.
However, we believe these figures do not derail the gradual slowdown in inflation towards the European Central Bank’s (ECB) 2% target for core inflation as poor growth prospects in the eurozone are likely to weigh on both prices and wages. Given this context, several ECB policymakers have begun to talk about the risk of inflation lastingly undershooting that target.
In our view, the way is clear for further rate cuts by the ECB. The German 10-year Bund yield moving above 2.40% on 1 November does not seem to fairly reflect the economic reality and the prospects of further rate cuts.
Finally, it is worth noting that ECB Executive Board member Isabel Schnabel said in late October that the US elections are ‘a big event’ which ‘could be quite significant for monetary policy, depending on what [happens]”.
There is perhaps no better way to paraphrase what comes next.
