Treasury yields are like the foundation that the rest of financial markets are built on. When the foundation is shaking, it is hard for other segments to find their footing.

For example, the S&P 500 is about 8% below its year-to-date high reached on July 31. U.S. small caps are down nearly 14%. The utilities sector, which is often viewed as a “safe-haven” given its highly consistent revenue profile, is down over 15%.

European equities have been able to hang in a bit better (-6% since the end of July), but are still unnerved by the bond market move (10-year German yields are up by 33 basis points since the end of September).

So what is behind the move in rates?

Let’s start with the fundamentals.

Growth: Third quarter U.S. GDP growth was probably 3% or higher, and there is growing evidence that the durable tailwinds to the economy are being underestimated. The latest revisions to U.S. GDP data released last week showed that construction spending on manufacturing facilities is up 75% from the pre-pandemic pace. Before the revisions, the data suggested that it was “only” up 40%. This surge is likely due to U.S. industrial policy, and could last for a few more years.

Monetary Policy: Because growth has been resilient, the Federal Reserve is no longer expected to be lowering interest rates any time soon. The first Fed meeting where markets think the most likely outcome is a rate cut isn’t until June of 2024. 

And now for everything else:

Fiscal deficits: The Treasury is likely to issue more bonds in the future to finance the deficit, which all else equal should increase bond yields.

Washington dysfunction: The drama in the House of Representatives does not help dispel the perception that the government lacks the composure to deal with important longer-term issues around its own finances.

Technical market factors: Positioning, momentum and trend-following strategies could all be exacerbating the moves.

What happens next? We expect rates to stabilize, and eventually fall. Here is why. 

Growth should slow down: We see a few clear headwinds that lead us to expect a deceleration in the fourth quarter: the restart of student loan payments, a reversal in momentum for the housing sector, a potential government shutdown and stagnant capital markets should weigh. Into 2024, higher interest costs continue to roll through the economy. As interest costs take up a higher share of income for corporations and consumers, it diverts their ability to invest in capex, make new hires, and spend on discretionary items. Real policy rates are on track to surpass real growth over the next two quarters. In the five other instances we have observed since 1980, growth slowed within three quarters in all but one of them.

Inflation is still decelerating: Inflation, as measured by the Fed’s preferred metric, hit 3.9% year-over-year (YoY) in August, a 27-month low. While above the Fed’s target, under the surface we have seen a sharp deceleration. The three-month annualized rate of change in core inflation was 2.2% in August. A slower pace of growth should keep that on track.

The Fed remains on hold: Weaker growth and inflation trending towards target should keep the Fed on hold from here. Historically, yields across the Treasury curve head lower after the end of the Fed’s hiking cycle. We think this pattern will hold; the market just needs clarity that the Fed is actually done. 

Today’s labor market data was strong, but wage growth was not a concern. The inflation focus will be on next Thursday’s Consumer Price Inflation release. But if things progress as we expect them to, markets should settle down up.

Investment implications: What can you do about it?

We see three clear takeaways for investors: bond yields suggest attractive returns, the equity market dip is providing an entry point and we still feel great about multi-asset portfolios.

Bonds look attractive. Treasury bond markets have gone a long way towards pricing out a recession and compensating investors for additional uncertainty. Markets are assuming that policy rates will remain above 4% for the next 10 years. We think this rate is probably too high. That suggests that longer-dated bonds have value. In the municipal space, we are starting to see more issues that have a 5% coupon trade at par value. This has only happened three times in the last 15 years and has consistently provided a ceiling for municipal yields.

As do equities. Earnings expectations are still climbing, while the drawdown has brought valuations back in line with the 10-year average level. From here, we think earnings season (which starts next Friday), positive seasonal trends and stabilizing bond yields will help equities start to rally again. Looking out, we think the chances are better than not that the S&P 500 makes a new all-time high by the middle of next year due to decent earnings growth and valuation expansion as inflation fades further.

Finally, we think that multi-asset portfolios are well positioned to deliver for investors. Equities provide the upside potential in the case that our view plays out, or we end up getting into a bull case where in 2024 equities surge because inflation comes back down to 2% and the Fed is lowering interest rates. Meanwhile, fixed income can provide the protection that we rely on in case growth slows more dramatically than we expect. If a recession does happen, it seems like interest rates would be poised to fall, and investment grade bonds could rally. If our view plays out, fixed income yields are at levels that suggest healthy total returns even if nothing changes. From here, both parts of the traditional 60/40 portfolios are poised to continue to do their jobs for investors (a global 60:40 stock:bond portfolio has returned nearly 5% year to date, while a U.S. 60:40 has returned nearly 7%).

Market sell-offs can be painful for those who are already invested, but we would encourage those folks to remember their plan. Perhaps the right course of action is to acknowledge that volatility is normal and that you are still on track to reach your goals. For others, a conversation about the options that higher bond yields provide to achieve similar returns with less risk could be appropriate. Yet another group may look at the sell-off in equities and see an opportunity to add exposure to portfolios, like we do.

No matter you and your family’s situation, your J.P. Morgan team is here to discuss opportunities we see in the context of your overall plan.

All market data from FactSet and Bloomberg Finance L.P., 10/6/23.

DISCLOSURES

Small capitalization companies typically carry more risk than well-established "blue-chip" companies since smaller companies can carry a higher degree of market volatility than most large cap and/or blue-chip companies.

International investments may not be suitable for all investors. International investing involves a greater degree of risk and increased volatility. Changes in currency exchange rates and differences in accounting and taxation policies outside the U.S. can raise or lower returns. Some overseas markets may not be as politically and economically stable as the United States and other nations. Investments in international markets can be more volatile.

Given the complex risk-reward trade-offs involved, we advise clients to rely on judgment as well as quantitative optimization approaches in setting strategic allocations. Please note that all information shown is based on qualitative analysis. Exclusive reliance on the above is not advised. This information is not intended as a recommendation to invest in any particular asset class or strategy or as a promise of future performance. Note that these asset class and strategy assumptions are passive only – they do not consider the impact of active management. References to future returns are not promises or even estimates of actual returns a client portfolio may achieve. Assumptions, opinions and estimates are provided for illustrative purposes only. They should not be relied upon as recommendations to buy or sell securities. Forecasts of financial market trends that are based on current market conditions constitute our judgment and are subject to change without notice. We believe the information provided here is reliable, but do not warrant its accuracy or completeness. This material has been prepared for information purposes only and is not intended to provide, and should not be relied on for, accounting, legal or tax advice. The outputs of the assumptions are provided for illustration/discussion purposes only and are subject to significant limitations.

“Expected” or “alpha” return estimates are subject to uncertainty and error. For example, changes in the historical data from which it is estimated will result in different implications for asset class returns. Expected returns for each asset class are conditional on an economic scenario; actual returns in the event the scenario comes to pass could be higher or lower, as they have been in the past, so an investor should not expect to achieve returns similar to the outputs shown herein. References to future returns for either asset allocation strategies or asset classes are not promises of actual returns a client portfolio may achieve. Because of the inherent limitations of all models, potential investors should not rely exclusively on the model when making a decision. The model cannot account for the impact that economic, market, and other factors may have on the implementation and ongoing management of an actual investment portfolio. Unlike actual portfolio outcomes, the model outcomes do not reflect actual trading, liquidity constraints, fees, expenses, taxes and other factors that could impact the future returns. The model assumptions are passive only – they do not consider the impact of active management. A manager’s ability to achieve similar outcomes is subject to risk factors over which the manager may have no or limited control.

The views contained herein are not to be taken as advice or a recommendation to buy or sell any investment in any jurisdiction, nor is it a commitment from J.P. Morgan Asset Management or any of its subsidiaries to participate in any of the transactions mentioned herein. Any forecasts, figures, opinions or investment techniques and strategies set out are for information purposes only, based on certain assumptions and current market conditions and are subject to change without prior notice. All information presented herein is considered to be accurate at the time of production. This material does not contain sufficient information to support an investment decision and it should not be relied upon by you in evaluating the merits of investing in any securities or products. In addition, users should make an independent assessment of the legal, regulatory, tax, credit and accounting implications and determine, together with their own financial professional, if any investment mentioned herein is believed to be appropriate to their personal goals. Investors should ensure that they obtain all available relevant information before making any investment. It should be noted that investment involves risks, the value of investments and the income from them may fluctuate in accordance with market conditions and taxation agreements and investors may not get back the full amount invested. Both past performance and yield are not a reliable indicator of current and future results.

The Standard and Poor's 500, or simply the S&P 500, is a stock market index tracking the stock performance of 500 of the largest companies listed on stock exchanges in the United States. It is one of the most commonly followed equity indices.

The Standard and Poor’s 500 Index is a capitalization-weighted index of 500 stocks. The index is designed to measure performance of the broad domestic economy through changes in the aggregate market value of 500 stocks representing all major industries.

The Bloomberg Eco Surprise Index shows the degree to which economic analysts under- or over-estimate the trends in the business cycle. The surprise element is defined as the percentage difference between analyst forecasts and the published value of economic data releases.

The NASDAQ 100 Index is a basket of the 100 largest, most actively traded U.S companies listed on the NASDAQ stock exchange. The index includes companies from various industries except for the financial industry, like commercial and investment banks. These non-financial sectors include retail, biotechnology, industrial, technology, health care, and others.

The MSCI World Index is a broad global developed markets equity benchmark designed to support: Asset allocation: Consistent, broad representation of the performance of developed equity markets worldwide, without home bias.

The Bloomberg Aggregate Bond Index or "the Agg" is a broad-based fixed-income index used by bond traders and the managers of mutual funds and exchange-traded funds (ETFs) as a benchmark to measure their relative performance.

The NYSE FANG+ Index is an equal-dollar weighted index designed to represent a segment of the technology and consumer discretionary sectors consisting of highly-traded growth stocks of technology and tech-enabled companies such as Facebook, Apple, Amazon, Netflix, and Alphabet's Google.

We believe the information contained in this material to be reliable but do not warrant its accuracy or completeness. Opinions, estimates, and investment strategies and views expressed in this document constitute our judgment based on current market conditions and are subject to change without notice.

RISK CONSIDERATIONS

• Past performance is not indicative of future results. You may not invest directly in an index.
• Investing in fixed income products is subject to certain risks, including interest rate, credit, inflation, call, prepayment and reinvestment risk. Any fixed income security sold or redeemed prior to maturity may be subject to substantial gain or loss.
• The price of equity securities may rise or fall due to the changes in the broad market or changes in a company's financial condition, sometimes rapidly or unpredictably. Equity securities are subject to 'stock market risk' meaning that stock prices in general may decline over short or extended periods of time.
• The prices and rates of return are indicative, as they may vary over time based on market conditions.
• As a reminder, hedge funds (or funds of hedge funds) often engage in leveraging and other speculative investment practices that may increase the risk of investment loss. These investments can be highly illiquid, and are not required to provide periodic pricing or valuation information to investors, and may involve complex tax structures and delays in distributing important tax information. These investments are not subject to the same regulatory requirements as mutual funds; and often charge high fees. Further, any number of conflicts of interest may exist in the context of the management and/or operation of any such fund. For complete information, please refer to the applicable offering memorandum.
• Structured products involve derivatives and risks that may not be suitable for all investors. The most common risks include, but are not limited to, risk of adverse or unanticipated market developments, issuer credit quality risk, risk of lack of uniform standard pricing, risk of adverse events involving any underlying reference obligations, risk of high volatility, risk of illiquidity/little to no secondary market, and conflicts of interest. Before investing in a structured product, investors should review the accompanying offering document, prospectus or prospectus supplement to understand the actual terms and key risks associated with the each individual structured product. Any payments on a structured product are subject to the credit risk of the issuer and/or guarantor. Investors may lose their entire investment, i.e., incur an unlimited loss. The risks listed above are not complete. For a more comprehensive list of the risks involved with this particular product, please speak to your J.P. Morgan team.
• Additional risk considerations exist for all strategies.
• The information provided herein is not intended as a recommendation of or an offer or solicitation to purchase or sell any investment product or service.
• Structured products are complex debt obligations of a corporate issuer the return of which is linked to the performance of an underlying asset. They are significantly riskier than conventional debt instruments and may not be suitable for all investors.
• Investment in alternative investment strategies is speculative, often involves a greater degree of risk than traditional investments including limited liquidity and limited transparency, among other factors and should only be considered by sophisticated investors with the financial capability to accept the loss of all or part of the assets devoted to such strategies.
• Opinions expressed herein may differ from the opinions expressed by other areas of J.P. Morgan. This material should not be regarded as investment research or a J.P. Morgan investment research report.

IMPORTANT INFORMATION

All companies referenced are shown for illustrative purposes only, and are not intended as a recommendation or endorsement by J.P. Morgan in this context.

Bonds are subject to interest rate risk, credit and default risk of the issuer. Bond prices generally fall when interest rates rise. Investing in fixed income products is subject to certain risks, including interest rate, credit, inflation, call, prepayment and reinvestment risk. Any fixed income security sold or redeemed prior to maturity may be subject to substantial gain or loss.