A tough time for fixed income investors

A weak nonfarm payrolls print

The US nonfarm payrolls print for September came out at +29,000, well below the consensus forecast of +90,000. In addition, the prior two months were revised down by a collective 60,000.

The three-month average was steady at +50,000. Fewer than half of the industries in the US added jobs last month.

There was not much good news in the reading. Average wage growth declined to +3% year-on-year, with little sign that it will pick up soon. The unemployment rate ticked up to 4.2%.

By all measures, it was a weak print, despite strong GDP growth (more below). In response, the US 10-year bond yield dropped by six basis points, but then rebounded and ended a few basis points higher than at the open. It is concerning that the US 10-year bond yield ended the day higher even after the weak nonfarm payrolls print.

A tough time for fixed income

The key theme running through global markets over the past few months has been the near-universal increase in bond yields. Since the war with Iran began, the US 10-year bond yield has risen by 129 bps (1.29 percentage points). Most emerging markets have seen smaller increases (and China’s 10-year bond yield has moved down). France’s 10-year bond yield has moved up 165 bps.

France now borrows more expensively than Italy at the 10-year maturity, and there are growing concerns that something is going to break in Europe.

France’s problems boil down to an unsustainable fiscal path, with GDP growth barely above zero. The election next year may add to uncertainty. On that score, part of the issue in France is the political inability to rein in the deficit. The bond market is pricing in around three notches of downgrades to French sovereign debt.

Higher long-bond yields appear to be having a negative effect on European equities, too, with the Eurostoxx 600 weakening relative to bonds.

Real yields in the US and elsewhere have ramped up, too. It is not often that the US 10-year real yield is above potential growth. Mortgage rates have ticked up, too.

One of the key risks we discussed at our recent investment strategy team meeting (the Global Investment Strategy Group) was the potential for higher yields to cause something to break, leading to weak or negative equity returns. Fixed income has been loss-making across a range of countries over the past one, three, six and 12 months. Equities have provided better returns, but even so, the last month was weak, with global equities down and declines across the countries we track, excluding Japan and the US.

While US Treasuries haven’t provided much protection of late, the US dollar has been strong. The US dollar strengthened by over 2% last month alone as it became apparent that the US economy was reaccelerating while growth across the rest of the globe was slowing.

Starting yields are now sufficiently high that even if we see a 100 bps (one percentage point) upward parallel shift in the yield curve over the coming year, US 10-year bonds would only lose around 2.5%, according to JPMorgan Asset Management. 

US core PCE inflation moderates

Last week, August US core personal consumption expenditure (PCE) inflation moderated to 3%. This implies that some pressure could be taken off the Fed to hike rates, especially when combined with the weak nonfarm payrolls print.

The near-term inflation signal suggests inflation will come down, too. The three-month annualised core PCE inflation rate moderated to 2.5%.

Median month-on-month inflation would see core PCE inflation reach 2% in the first quarter of next year. One should be mindful of the surge in energy prices in September, which may add inflationary pressures, however. According to Bloomberg consensus forecasts, core PCE in 2027 will average around 2.6%.

The softer inflation print and the weak nonfarm payrolls number have shifted the outlook, but the Fed is still expected to hike over the coming year.

There’s been a sizeable upward revision to second-quarter real GDP growth in the US

Last week, the Bureau of Economic Analysis released the third estimate of economic growth in the second quarter. The print showed a marked upward revision, from 1.5% to 2.2%.

‘Core’ GDP growth was also revised up from 4.2% to 4.6% annualised. This strips out net exports and changes in private inventory, looking at total inflation-adjusted spending by US residents plus private fixed investment. Real spending, however, is still ahead of real disposable income.

Spending patterns do not match the confidence numbers. Consumer confidence in the US plunged to its lowest levels since April 2014, and came in well below consensus (actual: 81.9, consensus forecast: 89).

One of the results of the upward revision in growth was a downward revision in the Atlanta Fed GDPNow estimate for the third quarter. Even with the revision, third-quarter GDP growth is still running at 3.7% annualised, well ahead of the consensus estimate.

Nominal GDP growth in the second quarter was 8.5%, enough to help with the debt problem (assuming nominal yields don’t follow).

Another supply chain pressure point

Recent increased conflict in the Black Sea threatens grain exports, which in turn threatens food price inflation.

There has also been a recent surge in the Food and Agriculture Organisation’s global food price index, which tracks global agricultural prices. It has reached its highest level since the tail end of 2022.

The Black Sea region makes up roughly 25% of global grain exports. Cereal carries a 25% weight in the index, implying a direct index exposure of approximately 7%.

There has been a dislocation in the relationship between changes in the index and global inflation since the tail end of 2024. The difference between the two is low at the moment, but it has been volatile in the past.

There has also been an uneven impact on agricultural commodity prices over the last month. Barley is up +42% over the last month, while corn, wheat and maize are lower. The 12-month change in the various agricultural commodities remains a challenge.

Like the Strait of Hormuz, a stop to the conflict in the Black Sea could meaningfully assist in normalising supply and hopefully reducing prices. Input cost pressures remain a concern. 

SA tax revenue continues to be strong

South African government revenue in August was R197bn, up 11% year-on-year. Based on our model, we now expect government revenue to exceed the February Budget forecast by approximately R100bn, allowing scope for tax cuts in February.