Markets Remain Calm Despite Rising 10-Year Treasury Yields

This week, highly-rated U.S. corporate bonds have been a source of stability, standing out amid the volatility that has impacted both the stock market and U.S. Treasury securities. Despite ongoing concerns over the upcoming November election, corporate bond spreads, which reflect the additional return investors demand to compensate for risks over and above Treasury yields, have remained relatively stable. This stands in contrast to the stock market, which saw significant declines on Wednesday, and the 10-year Treasury yield, which ended at 4.24%, its highest level in approximately three months.

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A chart from BondCliQ highlights how narrow corporate bond spreads have been in recent weeks, even as long-term Treasury yields have been climbing, leading to higher overall nominal yields. This dynamic has benefited investors by offering more attractive coupon rates. While spreads have slightly widened in recent days, the increase has been modest compared to the turbulence seen in other financial markets.

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Bryce Doty, a senior portfolio manager at Sit Investment Associates, noted that the rising yields have been a boon for yield-hungry investors. However, he also pointed out that spreads on corporate bonds have started to widen a little, indicating some caution creeping into the market. Spreads represent the premium investors demand above risk-free Treasury yields to account for factors such as default risk and broader market instability. In the case of highly-rated U.S. corporate bonds, these risks are relatively low, as the companies issuing these bonds are considered financially sound. This is particularly true given the recent resilience of the U.S. economy, despite persistent high interest rates.

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Doty speculated that the midweek jitters in the market were likely caused by concerns over the 10-year Treasury yield potentially reaching levels that could negatively affect the broader economy. If yields continue to rise, it could put pressure on the Federal Reserve’s ability to cut interest rates, a scenario that could lead to renewed market turbulence. He emphasized that any economic news suggesting continued strength could paradoxically be viewed as bad news for the markets if it delays or disrupts the Fed's plans for rate cuts.

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Nevertheless, Doty remains optimistic about the prospect of a so-called “soft landing” for the economy. He expects the Federal Reserve to cut interest rates by 25 basis points during its two remaining meetings this year, with further cuts likely to follow. He suggested that the Fed could take cues from the Bank of Canada, which recently implemented a 50-basis-point rate reduction. This outlook suggests that while the current market environment is characterized by uncertainty, a measured approach from central banks could help stabilize financial markets in the months ahead.

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On Wednesday, the corporate bond market experienced relatively minor losses, with the iShares iBoxx $ Investment Grade Corporate Bond ETF (LQD) dropping by 0.2%. In contrast, the stock market saw more significant declines, with the Dow Jones Industrial Average falling by 1%, the S&P 500 declining by 0.9%, and the Nasdaq Composite closing down 1.6%, according to data from FactSet. This divergence between the bond and stock markets reflects the broader uncertainty investors are grappling with as they weigh the potential economic impact of rising interest rates against the backdrop of an election season that could further heighten market volatility.

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In summary, U.S. corporate bonds, particularly those issued by highly-rated companies, have demonstrated resilience in the face of broader market uncertainties. While spreads have edged slightly higher, they remain at historically low levels, signaling continued confidence in the creditworthiness of these companies. At the same time, the rise in Treasury yields has introduced an element of caution, as investors remain alert to the possibility that higher yields could complicate the Federal Reserve’s efforts to ease monetary policy. Nevertheless, the corporate bond market has thus far been a relative safe haven, even as the stock market faces heightened volatility and the path forward for interest rates remains uncertain.

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