U.S. stocks rose for a third straight session on Tuesday and bonds posted their best day since August on growing optimism that the Fed's rate-hike campaign is drawing to a close, as a series of Fed officials released doves.
The yield on the 10-year Treasury note closed at 4.654 per cent, down from 4.783 per cent on Friday, the biggest one-day drop since August 23, market data showed. The yield on the 2-year Treasury note fell to 4.982% from 5.077% on Friday, the lowest level since Sept. 8. The U.S. bond market was closed on Monday for the Columbus Day holiday.
In the stock market, as the US debt storm quickly subsided this week, the three major US stock indexes continued to rebound in recent trading days. The Dow was up 134.65 points, or 0.40%, at 33,739.30. The Nasdaq rose 78.60 points, or 0.58%, to 13,562.84. The S&P 500 rose 22.58 points, or 0.52 percent, to 4,358.24.
The CBOE Volatility Index, or VIX, a measure of fear in the market, fell 3.5% to 17.08 on Tuesday. Analysts say stocks have been supported by the recent sharp decline in Treasury yields, whose rapid rise this fall had worried stock investors.
Ellis Phifer, managing director of fixed income capital markets at Raymond James, said the Israeli-Palestinian conflict is driving a shift away from safety towards Treasuries. Adding further fuel to the fire is the slightly more dovish tone from the Fed.
Phifer thinks U.S. interest rates may have peaked. "Unless US economic data, including inflation, goes off the charts tomorrow and in the coming days, the Fed seems closer to ending rate hikes than continuing them." The Fed has sounded much more neutral than it did a year ago."
There is no doubt that the current volatility of US bond yields is still significant for related markets, including stock markets and foreign exchange markets. John Praveen, managing director and co-chief investment officer at Paleo Leon, said: "Everyone has one eye on the Middle East conflict right now and one eye on what's happening to bond yields. The fall in bond yields has been a key driver of recent market movements."
An interesting set of contrasts is that, despite ongoing geopolitical tensions over the Israeli-Palestinian conflict, US stocks are now in their third straight day of gains, seemingly unaffected by much risk aversion. Peter Tuz, president of Chase Investment Counsel, attributed Tuesday's rally to a sharp drop in bond yields, even as he acknowledged that "the risks to the world have risen substantially."
& quot; Given what happened in Israel, the movements yesterday and today did surprise me. But the flight to safe haven sent Treasury yields lower, which in turn was enough to push stocks higher. quot; "Tuz said.
Big Fed minutes out tonight
On the Fed front, following dovish comments Monday from Vice Chairman Thomas Jefferson and Dallas Fed President Logan, another top Fed official on Tuesday said they would end their campaign to raise short-term interest rates if long-term Treasury yields remain near their recent highs.
Atlanta Fed President Jeffrey Bostic said Tuesday that the central bank doesn't need to raise borrowing costs any further, that current policy is sufficiently restrictive and that 'many' effects of the Fed's rate hikes have yet to be felt. Bostick also believes that while the Fed's rate hikes so far have slowed the economy and lowered inflation, he does not expect a recession in the future.
On the same day, San Francisco Fed President Bill Daley argued that the neutral interest rate may be higher now than before the outbreak, but rates will not remain at their current high level indefinitely. "The recent tightening in bond yields means that financial conditions have tightened, and if they stay tight, the Fed may not need to do as much more," she said. That's why I say that depending on how things develop, or whether economic momentum changes, this could amount to another rate hike."
With a number of Fed officials recently arguing that the rise in long-term yields could replace further Fed rate hikes, Nick Timiraos, a well-known financial journalist known as the "new Fed News agency," also wrote on Tuesday that the rise in Treasury yields could extend the Fed's pause in interest rate hikes.
Timiraos said recent comments from top Fed officials suggested the central bank would hold rates steady at its Oct. 31-Nov. 1 meeting. Fed officials could then wait for economic and financial developments over the next month before deciding whether to raise rates in December. By December, officials will be able to see whether the recent tightening in financial conditions has persisted, and whether the recent progress in inflation has persisted.
Cme Group's Fedwatch tool shows that the probability of the Fed staying put at both its November and December meetings, leaving rates at their current 5.25-5.50 per cent range, is now as high as 71.6 per cent.
Next, investors will be watching closely for any hint in the minutes of the Fed's September meeting, to be released at 2 a.m. Thursday Beijing time, that the central bank may not follow through on another rate hike as indicated in its interest rate dot plot forecast, industry insiders said. Of course, given the overall hawkish tone of the Fed at this meeting, investors also need to be prepared for the hawkish message in the minutes to hit the market.
Robert Thompson, macro rates strategist at Royal Bank of Canada in Sydney, said the recent rise in yields may give the Fed additional reason to pause in the near term, but it is too early to conclude that the tightening cycle is over.