I was puzzled by the news stories following the release of data last week, with headline CPI declining to 0.2% MoM and remaining unchanged on a YoY basis from 2.7% as compared to June data, but lower ...
Capital Markets
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5 min read
The market seemed to have a “hurry up and wait” approach ahead of last Wednesday’s FOMC announcement, which largely came in as expected. No rate cut by the Fed, but Waller and Bowman dissenting provided a more dovish tilt to the last Fed meeting than we have had in some time. Notably, Chair Powell sounded quite hawkish in his statement and press conference, which pushed rates slightly higher through the market close on the day. Powell reiterated the patient approach of the Fed, the need to focus upon the dual mandates of price stability and maximum employment, and that the labor market remains “broadly in balance, but inflation concerns persist.
Friday’s always important NFP release provided some fireworks on the day, as data indicated some noise around the data as it came in at 73k versus 104k consensus, but more shocking was the massive revisions to prior data. June data was revised down to 14k from 147k, and May data was revised to 19k from 144k. The market took this as an incredibly bullish sign that the Fed would move to cut rates at the September meeting. The 2-Yr rallied a massive 28 basis points, moving from 3.95% to around 3.67% on the data. The 10-Yr sector of the curve fell 18 basis points from 4.38% to around 4.20% to close the week. The probability of a 25-basis point rate cut in September moved from around 68% prior to the FOMC meeting, down to around 41% after the meeting, then skyrocketed to 91% by Friday’s close. Naturally, suggestions that the Fed has missed the mark increased following the employment release. Last year, the FOMC approved a 50 basis point cut following sizeable revisions to payroll data that revised new job creation estimates by over 818k during the previous year. Could these recent revisions provide similar ammunition for a rate cut in September? The actual unemployment rate remains well within the full employment range despite the small 0.1% uptick to 4.2%. Now we have 2 more months of employment and inflation data to digest before the next meeting.
Market participants must also bear in mind that following cuts last year beginning in September to the Fed Funds Target Rate totaling 100 basis points, 10-year Treasury yields rose about 80 basis points as the cuts were being undertaken. I’m going to pay careful attention to any shifting tone from the Fed in the coming weeks to ascertain if my continued bias towards higher long-term interest rates remains a likely scenario, or if it is time to jump on the dovish bandwagon. I would still have to overcome concerns about elevated federal deficits and sticky inflation concerns that can keep the long-end of the yield curve higher even if the front-end declines. Additionally, we have observed an increase in the term premium required by investors at least partially attributable to concerns about the strength of US Treasuries as a safe-haven asset and the threats to the independence of the Federal Reserve, which is a hallmark of our economic system.
From the Municipal Desk (with contributions from Ryan Riffe):
The municipal market struggled to keep pace with Treasuries after another week of heavy new issuance. The market priced in $12 billion of supply, which was slightly above the 2025 weekly average of $11.5 billion. The shape of the curve was little changed by the end of the week, with the long end keeping pace with the front end. Negotiated deals were oversubscribed anywhere from 5 to 15 times for longer maturities, making it extremely difficult for street accounts to be allocated bonds in the primary. Competitive deals were aggressively bid, especially for the high tax burden states such as CT, NY, NJ, and MA. We continue to see accounts rotating out of short callable positions and into high-coupon current callable structures to lock in yield. There will be no letup in new issue supply next week as the market looks to digest the 3rd largest weekly calendar of $17.6 billion. Thus, we expect the municipal market to continue cheapening on a relative basis. Despite this, there are positive technical factors to provide a backstop for the market. August redemptions are expected to total approximately $29 billion, while the 30-day visible supply stands at $21 billion. This deficit, along with positive fund flows, should help to maintain momentum for municipals. Municipal ratios as a percentage of Treasuries continue to offer value in longer-dated maturities. Despite limited sponsorship in the 30-year area of the curve, ratios above 95% are attracting some crossover buyers for 5% coupons priced at a discount. Supply/Demand dynamics have certainly led to a cheapening of the long-end of the municipal curve as demand, though solid, cannot keep pace with the record-setting pace of supply.
Municipal Ratios as a Percentage of Treasuries
3-Yr Ratio 63%
5-Yr Ratio 65%
10-Yr Ratio 77%
30-Yr Ratio 96%
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