LPL Research provides its midyear bond and commodity market outlook on interest rates, Federal Reserve rate cuts, gold, the U.S. dollar, and much more.

The Jekyll and Hyde Bond Market: A Tug of War Between Economic Data and Deficit Spending

Within fixed income markets, a tug of war has unfolded between two opposing forces, much like the classic tale of Dr. Jekyll and Mr. Hyde. The benevolent Dr. Jekyll emerges when economic data suggests weakness, which leads to lower interest rates and relief for borrowers. However, the menacing Mr. Hyde appears in response to America’s mounting federal debt and deficit spending concerns, which pushes rates higher via a higher Treasury term premium. And while we think the interplay between the good (lower rates) and bad (higher term premium) will persist throughout the rest of the year, given the still resilient economic conditions, we think rates, particularly the 10-year Treasury yield, could drift higher in the near term before ending the year between 4.0% to 4.5%.

A Mr. Hyde Bond Market

Deficit spending serves as the catalyst that transforms the bond market’s Dr. Jekyll into the fearsome Mr. Hyde. When the federal government spends beyond its means, it must issue new debt securities to make up the difference between revenue and outlays. Further complicating the picture for lower Treasury yields is potentially waning demand from foreign buyers as well as a yield curve that is still too flat, in our opinion.