Q4 2023 Market Commentary
Financial markets produced strong returns in the fourth quarter. Treasury yields, which spiked during the third quarter, reversed, and started to decline due to easing inflation and the Federal Reserve hinting at interest rate cuts in 2024. The decline in interest rates was the primary catalyst for both stocks and bonds, with bonds producing their best quarterly return since the second quarter of 1989.
Treasury Yields Reverse Lower in Fourth Quarter
During the fourth quarter, longer-term yields reversed sharply and erased nearly all the increase from the previous quarter. This quick and sharp reversal in long-term yields is likely due to a significant change in expectations heading into 2024.
During the third quarter, Investors had two key concerns, both of which contributed to the sharp rise in Treasury yields. First, the U.S. economy continued to outperform expectations, which raised concerns that the Federal Reserve might need to keep interest rates high for an extended period to continue fighting inflation. Second, the fiscal deficit was growing quickly as government spending increased. Investors were concerned the U.S.
Treasury would finance the growing deficit but that there wouldn’t be enough buyers for the new bonds, potentially causing yields to rise if supply outweighed demand.
A notable shift occurred in November, leading to a sharp reversal in Treasury yields. Investor worries about increased Treasury bond issuance were alleviated as the U.S. Treasury revealed plans to slow the pace of bond issuance. The market felt there would be enough demand to absorb the new bonds, lowering the probability that too much bond supply would cause yields to rise. Additionally, economic data indicated that inflation continued to decline even as economic growth continued to exceed expectations. Investors’ fears about persistent inflation and high interest rates started to fade, and yields declined.
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