Investors approached Thursday’s trading session with a sense of caution, refraining from making any significant moves in the stock market. This cautious stance prevailed despite the continued decline in U.S. bond yields for the sixth consecutive session. Lower bond yields are generally viewed favorably by investors as they tend to support stocks and other risk assets. This is because lower yields can reduce borrowing costs for both companies and households, thus providing a favorable environment for economic activities.
However, despite the potential benefits of lower bond yields, the market mood seemed somewhat uncertain. This hesitancy was evident even as the S&P 500 and Nasdaq Composite indexes reached new record highs on Wednesday. Additionally, credit spreads, which measure the difference in yield between riskier assets like corporate bonds and safer assets like Treasuries, were approaching historically tight levels. Investors appeared to be pinning their hopes on the concept of a “soft landing” for the U.S. economy, accompanied by gradual interest rate cuts by the Federal Reserve.
Mike Sanders, who serves as a portfolio manager and heads the fixed-income division at Madison Investments, expressed a degree of concern regarding the potential trajectory of the labor market. He suggested that if the Fed were to lower rates due to signs of weakness in the labor market, the rate cuts could be more substantial than currently anticipated. Sanders indicated that in such a scenario, rate cuts of 50 basis points at a time, at a minimum, could be on the table. However, he also acknowledged that smaller cuts of 25 basis points might still be considered if the labor market remains resilient and inflation continues to ease towards the Fed’s target of 2% annually.
Despite these considerations, Sanders warned that if the labor market were to significantly weaken, it could have adverse implications for both credit and equity markets. A deteriorating jobs market could also impact investors who are currently earning around 5% interest on cash and money-market funds, particularly if the Fed implements sharp rate cuts. As of June 5th, an estimated $6.09 trillion was held in U.S. money-market funds, according to data from the Investment Company Institute.
Sanders pointed out that while such investment strategies may have seemed prudent earlier in the year when inflation appeared to be stabilizing above the Fed’s target, the opportunity to secure yields of around 5.5% on high-quality corporate bonds may be diminishing. Furthermore, benchmark bond yields, which serve as a reference for new loans across the economy, have been trending lower. For instance, the 10-year Treasury yield stood at 4.28% on Thursday, representing a notable decline from its peak of 5% in October.
Sanders likened the current environment to the well-known adage about stocks ascending gradually but descending rapidly. He cautioned that many investors have been opting to keep cash in money-market funds rather than extending the duration of their investments. While this strategy may have been effective thus far, Sanders suggested that its effectiveness may be limited in the face of evolving market conditions.