Chair Powell’s speech at Jackson Hole suggests that President Trump will be getting the rate cut he wanted; it’s just a question of when. His comments validated the market’s sentiment that has been priced in by traders for the past few weeks. Most notably, he stated, “downside risks to employment are rising.” Furthermore, the effect of tariffs increasing prices on the consumer are “now clearly visible” and “will be relatively short-lived.” This suggests a shift in the sentiment at the FOMC regarding the more immediate danger that the risk of a weakening labor market can damage the growth of the economy. Markets reacted sharply, with both equities and bonds rallying on the news. The S&P 500 shot higher by over 100 basis points on enthusiasm for the continued economic growth in a lower rate environment, nearly eclipsing the all-time high from the previous Friday. Additionally, the Treasury curve bull steepened with 2-Yr rates sharply dropping by 10 basis points, 10-Yr rates falling by 6 basis points, and 30-Yr yields falling by a modest 3 basis points on the initial news.
I continue to urge investors to avoid conflating interest rate cuts on the front-end of the curve with the ongoing challenges that can keep the longer-end of the interest rate curve higher than otherwise expected. Long-end levels can remain higher based upon elevated term premium expectations for a variety of reasons, including high and rising US debt levels, continued inflationary concerns on President Trump’s tariff policies, and worries about the safe-haven status of US investments. For this reason, I expect the relatively steeper US Treasury yield curve to remain upwardly sloping and possibly steepen further, led by a front-end rally with limits to how low longer-term maturities can decline. Specifically, 10-Yr rates can push lower from the present 4.25%-ish level, but any exuberance that we can expect a larger and sustained rally on longer-term maturities should be tempered.
As attributed to John Maynard Keynes, the quote, “When the facts change, I change my mind. What do you do, sir?” applies to my thoughts on the likelihood of Fed rate cuts. Prior to today, I was firmly in the zero-cut camp. Following Chair Powell’s speech, however, I expect the Fed will begin to cut the Fed Funds Target Rate with a reasonable (50:50) chance that the first cut occurs in September. Despite the aforementioned shift in sentiment within the Fed, the door remains open for no cut in September as we have August jobs data, PPI, CPI, and PCE to digest prior to the decision. It bears mentioning that the Fed has never in its history made a single 25 basis point rate cut and then paused with no rate cut at the subsequent meeting. Historically, policy shifts often occur with a series of actions intended as a response to economic indicators. Based upon Chair Powell’s comments at Jackson Hole, the Fed’s interpretation of economic indicators is shifting, thereby signaling a change in monetary policy designed to manage their dual mandates with a lean towards concerns about employment exceeding worries about inflation.
From the Municipal Desk (with contributions from Ryan Riffe):
A relatively quiet week in terms of movement of the MMD Scale as we tiptoed closer to Friday's Jackson Hole discussion. The market displayed some strength at the front end of the curve early in the week, while the long end experienced some selling pressure. The new issue calendar dropped to just $9 billion, roughly half of what the market experienced in prior weeks. This change in supply was met with a wave of more than $2 billion in inflows into municipal mutual funds. Front-end UST/Muni ratios continued to richen, with the 2-year ratio hitting 59% intra-week. A notable disconnect has emerged between Variable Rate Demand Notes (VRDNs) and fixed-rate munis on the short end. With SIFMA now sitting more than 55 basis points higher at 2.78%, we believe the front end is considerably overbought and recommend waiting for more attractive entry points. With one full week of August remaining, we head into September, which is historically one of the lightest months for municipal reinvestment capital. If weekly supply continues to price below average levels ($10.6 billion) and inflows remain positive, we believe municipals will likely strengthen relative to Treasuries.
$7.9 Billion of New Issue to be priced in week ending Aug. 29
Ratios versus US Treasuries
3-Yr 60%
5-Yr 63%
10-Yr 76%
30-Yr 94%
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