A Bond Selloff Pushes Yields To Their Highest Since 2007

Government bonds sold off hard on Wednesday, and the ten-year Treasury yield closed at its highest level since 2007. A strong survey of American businesses and a badly received $70 billion auction got it there, and stocks gave ground. Washington supplied the one bright spot: the tariff truce with China, due to lapse in November, now runs to January 10.

Fast Facts

• Wednesday's selling was broad: the S&P 500 fell 0.75% to 7,706.03, the Nasdaq Composite fell 1.13% to 26,936.04, and the Dow gave up 352 points (Read More)
• Brightline, the Florida passenger railroad backed by Fortress Investment Group, plans an imminent Chapter 11 bankruptcy filing after struggling with $5.5 billion of debt (Read More)
• Meta unveiled Muse Charm at its Connect conference, a keychain-sized device built around Muse, its artificial-intelligence helper, which Meta aims to ship in time for the December holidays (Read More)
• A $2.50 monthly increase took standalone Disney+ and Hulu plans to $21.49 (Read More)
• eBay banned sales of airbags and airbag components on its marketplace as concerns grow about faulty and counterfeit auto parts (Read More)
• Activist investor Starboard Value pressed construction-materials company Knife River to explore a sale; the stock fell more than 7% on Wednesday after the company forecast continued headwinds (Read More)

Global News

• German business sentiment hit a three-year high, with the Ifo Institute's president saying companies rated their current situation more positively as the economy kept recovering (Read More)
• Shares of the National Stock Exchange of India rose as much as 5.2% above their offer price on their first day of trading, after a $2.36 billion listing, India's second-largest (Read More)
• Volkswagen opened presales in China for the second vehicle it has developed with local partner Xpeng (Read More)
• Asian share markets were mostly lower on Thursday and European indexes opened in the red as the U.S. bond selloff traveled outward (Read More)

Treasury Yields Hit 19-Year Highs After A Hot Survey And A Weak $70 Billion Auction

U.S. government bonds sold off across every maturity on Wednesday. The 10-year Treasury note, the benchmark for long-term U.S. borrowing, closed at 5.11%, up 15 basis points, which is 15 hundredths of a percentage point. That is its highest close in the Treasury's published daily series since July 2007. The 2-year note, which tracks where investors think the Federal Reserve is heading, rose 14 basis points to 4.85%, and the 30-year bond added 11 basis points to end at 5.40%. Two things set it off. S&P Global's preliminary September survey of purchasing managers came in far above expectations, its composite measure of business activity at 58.4 against economists' average forecast of 55.3, where any reading above 50 means activity is growing. Then a $70 billion sale of five-year notes drew the weakest demand in years.

Stocks fell, though not dramatically. The Nasdaq Composite lost 1.13% and the Dow 0.68%. The gap is the point: profits a company will not earn for another decade are worth less today when safe government bonds pay more, and the Nasdaq holds more of those far-off profits. The dollar went the other way, reaching its strongest level against a basket of major peers since late July, because higher yields make dollar savings more rewarding to hold.

Here is the machinery underneath that. A Treasury security pays a fixed schedule of interest, so when buyers will only pay less for it, that same fixed payment works out to a bigger return for whoever buys next; price down, yield up, always in opposite directions. An auction is a live poll on what the government must pay to borrow right now. Wednesday's poll was unflattering. The Treasury had to pay 5.033% to place those notes, the most it has paid at that maturity since 2006, and total bids came to 2.212 times the amount offered, the lowest since December 2018. Government yields are the floor under nearly every other loan in the country, because almost no borrower gets a better rate than the U.S. government does. A widely watched daily rate tracker put the average 30-year fixed mortgage at 7.26%, up 9 basis points on the day.

A survey that strong describes an economy growing quickly, which is good news on its own. The complication is that it arrives alongside August's 0.4% rise in consumer prices and 4.1% unemployment rate, the combination that keeps a central bank raising rates. The Fed's target range for short-term borrowing sits at 3.75% to 4.00% after its September 16 increase, and Governor Michael Barr said Wednesday that "further policy adjustments are likely to be needed to ensure inflation comes down to target in a timely fashion." By the close, futures markets, where traders bet on where the Fed will set rates, implied roughly a 70% probability of another increase at the October 27-28 meeting. That is a price, not a forecast, and bets like it have been wrong before. What settles it is the next round of inflation and jobs data, and whether the coming auctions draw stronger bids than this one did.

Sources: U.S. Treasury · WSJ · Seeking Alpha · Yahoo Finance · CNBC · Rapunzl, Sept. 17 · Rapunzl, Sept. 15

The U.S.-China Tariff Truce Now Runs To January 10, Not November 10

Treasury Secretary Scott Bessent said Wednesday that the United States and China have agreed to push the expiry of their trade truce, the Busan Agreement struck last year, from November 10 to January 10. Bessent framed the two extra months as room to work toward "a bigger deal as opposed to just a series of smaller things," and said that by January the two sides might simply roll the arrangement forward again. Two months is shorter than many had expected. The announcement came hours after President Trump met Xi Jinping at the foot of his aircraft's stairs at Joint Base Andrews, the first time in 11 years a U.S. president has greeted a foreign leader at that base. It is Xi's first U.S. trip in nearly three years; the two are scheduled to meet at the White House on Thursday.

A tariff is a tax a government charges on goods crossing its border, and someone along the chain pays it: the importer at the port, the wholesaler, the retailer, or the shopper at the checkout line. Before Busan, the two countries had pushed tariffs on each other's goods into triple digits, which works less like a tax than a wall. The agreement pulled those rates down and restored the flow of rare-earth magnets and other critical minerals China had restricted. Rare earths are the raw inputs for electric-vehicle motors, wind turbines, semiconductors and defense hardware. A company that cannot buy the magnet does not build the motor.

What the extension buys is one dated risk off the calendar. Importers and retailers heading into the holiday quarter, when a big share of the year's sales happen, now know the rules will not change mid-shipment. What it does not buy is a settlement. Jens Eskelund, president of the European Chamber of Commerce in China, said an extension on its own leaves the practical problems where they were, including the absence of a standard process for applying for a rare-earth export license. The larger disagreements are open too: U.S. export controls on advanced chips, China's relationship with Iran, and U.S. support for Taiwan.

Sources: CNBC · Al Jazeera · Al Jazeera on the agenda · CNBC on the summit · Rapunzl, Sept. 21

McDonald's Will Spend $8.5 Billion On The Restaurants It Does Not Own

McDonald's told investors on Wednesday that it will direct about $8.5 billion to its franchisees, the independent operators who own and run most of its restaurants, through 2036, with roughly $5 billion of that arriving by 2030. The money, part of a strategy the company calls NEXT, is rent relief and capital support for remodels, new equipment, technology and crew training, aimed at two categories where McDonald's says it wants a bigger share of what customers spend: chicken and beverages. Management put a number on the return. The company estimates roughly a 250-basis-point efficiency gain, which is 2.5 percentage points, worth about $100,000 a year in additional cash for an average U.S. restaurant, with franchisees earning back their share in about four years.

The structure is the story here. McDonald's does not own most McDonald's. It franchises them: an independent operator owns the restaurant, hires the crew, buys the fryers, and sends the parent company rent and royalties, a share of sales, every month. So the parent's revenue is largely other people's rent checks, and its growth can stall even when the brand is healthy, because a squeezed operator does not remodel anything. Committing $8.5 billion to those operators is an admission that the squeeze is on the operators' side, not the corporate side. That is a franchise in one line: two separate balance sheets, two lists of what each side owns and owes, one shared fate. The number to hold onto is the four-year payback, the company's own estimate of how long an operator waits before the new fryer has paid for itself.

Sources: McDonald's SEC filing · Axios · WSJ · Yahoo Finance

What To Watch

Reporting today:

• Costco (COST) is expected after the close, today's largest reporter at roughly $399 billion in market value, with an average analyst estimate of $6.48 a share against $5.87 a year ago
• Darden Restaurants (DRI) is expected before the open at $2.06 against $1.97 a year ago, TD SYNNEX (SNX) at $4.46 against $3.47, and BlackBerry (BB) at $0.03

From Washington:

• President Trump is scheduled to host President Xi at the White House today
• The Federal Reserve's Senior Credit Officer Opinion Survey is scheduled for 2:00 p.m., and the Bureau of Economic Analysis is due to publish U.S. international transactions

Later this week and next:

• Gross domestic product, personal income and outlays, and corporate profits are scheduled for September 30
• Jefferies (JEF) is expected after Monday's close at $1.04 against $1.05 a year ago, and Vail Resorts (MTN) the same afternoon, where analysts expect a seasonal loss of $5.37 a share
• The Federal Reserve's next rate decision comes at its October 27-28 meeting

The Classroom Takeaway

Nobody sets interest rates alone: the Federal Reserve moves one rate, and investors at a bond auction decide the rest. The fastest way to feel the trade-off between growth and inflation is to make the call yourself, which is what running the Fed for a few minutes is for.