Though not exactly a scary thing to report, Friday’s market activity could appropriately be called, “A Quiet Place: The Day After”. As expected, with market participants either hung over, working thro...
Capital Markets
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5 min read
Whoa!!! Incredible market moves this past week along with the massive change in opinions from market participants on what the Fed “should” do have altered dialogue regarding the economic outlook. From the previous Friday’s close near 4.20% on 10-year UST to today’s extension down to the 3.80% support level, the market has experienced an incredible transition. Some pundits are calling for a cut before the Sept 17-18 meeting; others suggest a 50-basis point cut in September and more aggressive cuts to follow for the remainder of the year. Additionally, suggestions that the Fed missed the opportunity to cut at the July 31 meeting are resonating very loudly. Friday’s Nonfarm payroll (+114k vs +175k consensus) and unemployment ticking up to 4.3% added fuel to the fire. Notably, the Sahm Rule has been triggered with a greater than one-half percentage point move in the unemployment rate based on a 3-month moving average above the low of the previous year, thus suggesting that a recession is underway. Data clearly supports the narrative that the economy is weakening and the labor market is loosening. Now, concerns about the Fed’s ability to orchestrate an economic soft-landing while managing inflationary pressures without further hurting economic growth are making headlines.
As the above chart indicates, the inverted US Treasury yield curve is quickly approaching the zero-threshold barrier, and a steeper yield curve is expected in the near future. The 2-year/10-year yield curve has remained inverted for 26 months to this point. The ZIRP strategy and QE initiatives from the Fed, along with the incredibly stimulative CARES Act program to help during the COVID-19 crisis, resonated throughout the domestic economy for an extended timeframe following the conclusion of these stimulative efforts. Though 26 months is clearly a very long period without a recession coming to pass, the Great Recession in 2008 was preceded by an initial inversion 22 months prior in 2006. Furthermore, an inverted yield curve has preceded every recession dating back to the 1960’s. Coupled with the clearly challenging economic environment, the aforementioned triggering of the Sahm Rule, legitimate concerns about a recession, and the Fed’s need to aggressively pursue an accommodative fiscal policy, reinvestment opportunities on the front end of the curve should be at much less attractive levels over the next 2-year period.
Looking ahead, the strong market performance in July for fixed-income assets is expected to continue as we head through August. Specifically, the Bloomberg US Treasury index achieved +2.19%, the Bloomberg IG US Corporate Index returned 2.38%, and the Bloomberg Municipal Bond Index gained +0.91% in the month. Coupled with the flight to quality trade as equities are beginning to break down, strong demand for fixed-income products should catch the tailwind of ongoing heavy flows into bond funds and SMA portfolios seeking investment opportunities. We continue to advocate for extending duration despite rates being nearly 70 bps below the 4.50% level for the 10-year since we’ve been pursuing this approach. Concerns about inflationary pressures resuming are valid, especially given the potential for both Democratic and Republican Presidential policies in November adding to fiscal deficit and demonstrating limited concerns about constraining inflationary policy impulses. Despite this, the expectation that front-end rates will be much lower (with calls for as much as 300 basis points of Fed cuts over the next 12 months) suggests the opportunity to lock in some generationally attractive yields further out the curve should not be ignored.
SWBC client activity appeared to be relatively normal at the beginning of last week. However, the script changed dramatically following the arguably dovish Powell press conference and carried through further after the weaker employment data on Friday. It would not be an overstatement to suggest that buyers were “grabby” for the second half of the week. We notably heard from some portfolio managers prior to the Fed announcement that they were “hoping” for Powell’s comments and employment data to create a little weaker market dynamic and give them a chance to buy at cheaper levels. After this failed to come to fruition, investors were practically forced to chase the market down to lower levels.
An index is unmanaged and not available for direct investment. Definitions sourced from Bloomberg.
The Bloomberg Barclays Global Aggregate Negative Yielding Debt Market Value Index represents the portion of the Bloomberg Barclays Global Aggregate Index that measures the aggregate value of global debt with a negative yield. • The S&P 500® is widely regarded as the best single gauge of large-cap U.S. equities and serves as the foundation for a wide range of investment products. The index includes 500 leading companies and captures approximately 80% coverage of available market capitalization. • The NASDAQ Composite Index is a broad-based capitalization-weighted index of stocks in all three NASDAQ tiers: Global Select, Global Market and Capital Market. The index was developed with a base level of 100 as of February 5, 1971.• The Cboe Volatility Index® (VIX) is a calculation designed to produce a measure of constant, 30-day expected volatility of the US stock market, derived from real-time, mid-quote prices of weekly S&P 500® Index (SPX) call and put options with a range of 23 to 37 days to expiration.• The ICE BofA MOVE Index is a yield curve weighted index of the normalized implied volatility on 1-month Treasury options. It is the weighted average of implied volatilities on the CT2 (Current 2 Year Government Note), CT5 (Current 5 Year Government Note), CT10 (Current 10 Year Government Note), and CT30 (Current 30 Year Government Note), with weights 0.2/0.2/0.4/0.2 respectively.• The Markit CDX North America Investment Grade Index is composed of 125 equally weighted credit default swaps on investment grade entities, distributed among 6 sub-indices: High Volatility, Consumer, Energy, Financial, Industrial, and Technology, Media & Tele-communications. Markit CDX indices roll every 6 months in March & September. • The Markit CDX North America High Yield Index is composed of 100 non-investment grade entities, distributed among 2 sub-indices: B, BB. All entities are domiciled in North America. Markit CDX indices roll every 6 months in March & September. • The U.S. Dollar Index (USDX) indicates the general international value of the USD. The USDX does this by averaging the exchange rates between the USD and major world currencies. Intercontinental Exchange (ICE) US computes this by using the rates supplied by some 500 banks.
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