Two-year Treasury yield fell 11 basis points alongside the AI share selloff

The two-year Treasury yield fell 11 basis points from Wednesday's close to Friday, Oct. 30, when it ended at 4.56%, and the 10-year yield fell by the same amount. The drop came alongside a selloff in shares of companies spending on artificial intelligence.

The U.S. Federal Reserve met on Wednesday, Oct. 28, and held its benchmark rate. By that close, only 2 basis points of the two-year's 13-basis-point decline on the week were already in place.

Long yields rose on the day of the hold

On Wednesday the 10-year yield rose 6 basis points, to 5.05%, and the 30-year yield rose 7. The gap between the 10-year and the two-year widened to 38 basis points by that close, from 31 at the previous Friday's close. It finished the week at 38 basis points, because after Wednesday the two-year and the 10-year fell by the same amount. The 30-year yield ended 2 basis points lower on the week, at 5.31%.

The Federal Reserve held the target range for the federal funds rate at 3.75% to 4%, in a 10-2 vote. Lisa D. Cook and Beth M. Hammack dissented in favor of a quarter-point increase. A hike that day had not been the bet. On Monday, Oct. 26, CNBC reported that CME Group's FedWatch tool, which reads futures on the federal funds rate, put the chance of one at less than 10%.

"The overwhelming judgment is that what we've done in this monetary medicine is starting to work some, but there's no firm conclusions," Federal Reserve Chair Kevin Warsh said at that afternoon's press conference.

MUFG Research's U.S. macro strategy team wrote that day that markets priced roughly an 80% chance of a quarter-point increase in December, against its own 55%, and that December was "not a done deal."

Alphabet and Intel sold off

On Thursday, Oct. 29, the Bureau of Economic Analysis estimated that real gross domestic product grew at a 3.4% annual rate in the third quarter, up from 2.2% in the second. Jason Haley, chief investment officer at ALM First, had written on Monday that forecasters expected 3.2%. The bureau said the acceleration "primarily reflected an acceleration in investment and an upturn in government spending that were partly offset by a downturn in exports." The increase in investment, it said, was led by private inventories and by equipment, and within equipment by information processing equipment, mainly computers and peripheral equipment.

The personal consumption expenditures price index, published the same morning, rose 0.5% in September and 3.6% from a year earlier, up from 3.4% in August. The index excluding food and energy was up 3.1% on the year, from 3.0%.

Alphabet's class A shares fell 12.6% that day. Reuters reported that the company had said massive AI spending turned its cash flow negative. Treasury yields fell in that same session, which also carried the growth report.

On Friday Intel's shares fell 28.6%. Reuters reported that the company said demand for personal computers had slowed and could stay soft through next year. Intel and Amazon had each burned cash while investing in AI, Reuters reported, and Amazon's shares fell as well. The Nasdaq-100, higher through Wednesday, fell 3.5% on Friday and ended the week down 2.0%. The S&P 500 fell 1.8% on the day and 0.6% on the week.

Reuters reported that the sharp selloff in technology shares sent investors to the safety of U.S. bonds, on fears that heavy AI spending may not deliver sufficient returns.

High-yield spreads narrowed

Warsh said the policy would work by tightening financial conditions.

"The dominant means in which this policy is going to be put into practice is we are tightening financial conditions," he said.

Harder borrowing for high-yield companies would mean a larger extra yield over Treasuries. That extra yield got smaller through Thursday. On the ICE BofA US High Yield Index, it closed at 3.26%, 12 basis points narrower than the previous Friday, according to ICE Data Indices. The iShares iBoxx $ High Yield Corporate Bond ETF HYG rose 0.5% in price on the week, not counting payouts.

The drop in shares was not across the market. The Russell 2000 rose 1.3% on the week. The State Street Health Care Select Sector SPDR ETF XLV rose 3.1% in price. The State Street Communication Services Select Sector SPDR ETF XLC fell 5.3%.

The 10-year decline was the real yield

The 10-year yield ended the week at 4.94%, down 6 basis points. All of that decline was the real yield, the yield on 10-year inflation-protected Treasuries, which fell 6 basis points to 2.6%. Breakeven inflation, the gap between the two, was unchanged at 2.34%.

The funds that hold those bonds rose in price, not counting payouts. The iShares 7-10 Year Treasury Bond ETF IEF gained 0.8%, the iShares 20+ Year Treasury Bond ETF TLT gained 0.6%, and the iShares TIPS Bond ETF TIP gained 0.4%.

SPDR Gold Shares GLD fell 3.0% in price on the week, when the real yield fell, and 3.5% on Friday, when Treasury yields fell.

Breakeven inflation did not shrink in a week when the annual inflation rate rose. None of the week's decline in the 10-year yield came from a smaller inflation premium.