Interest rates appeared to be consolidating, with 10-year Treasuries trading just above 4.20% for the past week. Expectations for lower yields remain likely despite the greater than 50 basis point move in 10’s since the April peak at 4.735%. A more thorough analysis highlights the bull steepening trend that has taken hold as the likelihood of a Fed rate cut in September has become the expected norm. As of this writing, the market is pricing in a 100% chance for the Fed to cut its target rate by 25 basis points in September. The below chart highlights 2 very important curve changes that have occurred over the past several weeks. Notably, the 2’s-10’s (White Line) spread has narrowed to the tightest spread (-15 basis points) since the curve sustained its inversion in July 2022. Additionally, the 2’s-30’s spread (Yellow Line) has exceeded and maintained a positive slope. Such price action is textbook as a prelude to a Fed rate-cutting cycle.
Keep in mind that Fed policy action largely influences the front end of the curve, given the de facto nature of the Fed’s Target Fed Funds Rate. It should be no surprise that 2-year yields are compressing at a more rapid pace than their longer-term counterparts. The Fed appears very committed to maintaining a strong policy stance and has alluded to its receptivity towards reducing interest rates soon, which, as mentioned previously, the market is in complete agreement. Expecting further steepening, prudent investors that have benefitted from remaining anchored on the short end of the curve over the past 2 years should consider locking in some longer-term yields before the dis-inversion of the yield curve reduces the reinvestment attractiveness for short paper down the road.
Municipal ratios remain tethered to levels that fail to inspire attractive buying opportunities. The influx of positive cash flows into municipal funds, however, and the steady reinvestment monies for SMA portfolios have kept demand robust. As we move into August, new issue volume is slowing down as participants begin to enjoy the summer holidays. For this reason, along with the expectation that supply will have further reasons to be lighter as the election period approaches, I do not expect significant cheapening of municipal paper. SWBC clients have remained engaged and active buyers, though selective as to their approach. Inquiry and buying activity, particularly for specialty state paper, continues to be strong. Competition and the opportunity to position such paper is a challenge for dealers.
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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