NEW YORK (MarketWatch) — The sigh of relief felt in the U.S. bond market as Congress temporarily shelved its fiscal standoff is giving way to a more worrisome market signal: the economy isn’t as strong as we thought it would be by now.
The Treasury market has been on a tear in recent days, beginning in earnest as Senate leaders announced a deal Wednesday to reopen the government through January and allow the Treasury to continue borrowing through February. The benchmark 10-year note 10_YEAR +0.04% yield, which falls as prices rise, is down roughly 15 basis points from its close on Tuesday, on track for its lowest closing yield since August. Strategists say yields are likely to stay in this range in the near term, in contrast to the sharp yield climb that characterized much of the summer.
“We’re pretty comfortable saying the 10-year won’t see 3% this year. At this stage, the September yield peak will be the high of the year,” said Ian Lyngen, senior rates strategist at CRT Capital Group.
Treasury yields, which serve as benchmark rates, push lower when economic and political uncertainty prompt investors to buy into the security of the government debt market. When the Congressional standoff came to a close this week, strategists thought yields would rise as the abating political uncertainty turned investor attention away from Treasurys and back toward riskier assets. But yields made a U-turn and moved in the opposite direction, catching many market participants by surprise. It’s one sign that the debt ceiling debate had simply masked, and possibly contributed to, a slowdown in economic growth.
“Since the end of the debt ceiling conflict, the focus has shifted in financial markets to what the economic implications would be,” said Jeffrey Rosenberg, chief investment strategist for fixed income at BlackRock. “And it came at a time when the economy had been slowing down, when there was disappointment in what was at the time heightened expectations of better second half growth.
Rosenberg puts the turning point in economic growth around the beginning of September, when the nonfarm-payrolls report missed expectations. Since then, many indicators have begun to slip.
The government shutdown also had the dual effect of taking a bite out of economic growth as well as delaying, and potentially skewing the way the Federal Reserve measures growth. Data releases were delayed during the 16-day shutdown as federal workers who produce them were furloughed.
“That all has turned market expectations from the ‘escape velocity growth is around the corner’ [mentality] to ‘maybe here we go again,’” Rosenberg said.
Since the government shutdown, a number of research houses have revised their fourth-quarter projections for U.S. economic growth downward. Macroeconomic Advisers shaved 0.5% off its estimate, now 2.1%. IHS Global Insight is now forecasting 1.6%, versus 2.2% previously. And Capital Economics now projects 2% growth, down from 2.3%.
Further, many participants assume that fights in Congress will replay themselves when the government reaches the budget and debt limit deadlines it set for itself early next year. That uncertainty has pushed back projections of when the Fed will begin winding down its $85 billion in monthly bond buying. Expectations of withdrawing the stimulus that had held interest rates down in turn pushed yields sharply higher over the summer.
Many analysts expect Janet Yellen — who has been nominated to lead the Federal Reserve — will continue on a dovish policy path. As a result, some market participants are now honing in on a March time frame as the earliest possible time to begin the so-called taper.
“Tapering will be off the table until 2014,” said Matt Duch, portfolio manager at Calvert Investments. He added: “It’s getting bumpier and bumpier and you’re better off in a conservative investment.”
Strategists stopped short of saying bonds were set to rally. The Fed will inevitably have to scale back its bond purchases, but in the meantime, the pause in the benchmark interest rate’s climb may present opportunities. BlackRock, for one, upgraded some of its interest-rate sensitive sectors, such as Treasury and agency bonds to neutral from underweight at the beginning of the month.
Ben Eisen is a MarketWatch reporter based in New York.
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