Key Points:
- US Treasuries were downgraded by bond rating agency Fitch as the high debt burden continues to grow.
- Stocks saw their first decline after five consecutive months of gains with the S&P500 dropping 1.6%.
- Higher yields are being felt across the economy in the form of higher borrowing costs for consumers and businesses.
While investors continue to ponder if the US economy is headed into a recession, bond rating agency Fitch downgraded US Treasury debt in August. They cited the high and growing government debt burden along with the debt limit standoffs in Congress leading to last minute deals. This downgrade along with the increase in the level of government borrowing caused a dramatic rise in yields during August. The 10-year Treasury yield climbed to 4.35%, its highest level since 2007. Higher yields are putting pressure on the economy as the Fed tries to bring down inflation while not significantly slowing economic growth. 30-year mortgage rates are the highest in 20 years and seem to be keeping both buyers and sellers on the sidelines.
The increase in yields in the bond market hurt stock prices during the month as financing costs for both companies and consumers rose. Stronger than expected economic data has sparked worries that the Fed may have to continue raising interest rates towards the end of the year. The S&P500 fell 1.59% during the August after five consecutive months of positive gains. The only sector of the market that was positive was energy, which gained 1.8% with the recent jump in oil prices. Utilities (-6.2%) were the worst performers followed by consumer staples (-3.6%). These dividend paying sectors of the stock market tend to be bond proxies, so higher yields in bonds are more attractive. Small caps fell 5% while international developed (-3.8%) and emerging markets (-6.2%) sold off on worries on the Chinese economy.
The message from the Federal Reserve after the Jackson Hole meeting was that they still want to get inflation under control and will be data dependent on future policy decisions. Investors need to get used to the notion that rates will likely be higher for longer if the economy remains strong. Bonds lost 0.64% for the month (higher yields equals lower bond prices) as measured by the Bloomberg Aggregate Bond Index. However, bonds are still positive for the year and are paying attractive coupons that are finally higher than inflation. Stocks may have gotten ahead of themselves to start the year in the hopes that the US would avoid a recession. Coming into the final months of 2023 the market may remain a bit choppy as we see if the Fed can orchestrate a soft landing for the economy.
Sources: Morningstar Direct, Wall Street Journal, BEA.gov