Market Commentary: Week of September 16, 2024

Though there were no particularly earth-shattering developments last week, some important happenings did occur. Notably, the 2’s-10’s spread pressed into positive territory after disinvesting and maintained a positive slope (though it briefly tested the zero-basis-point bound from the high side after re-steepening). I’ve been on my front foot, expecting this development as we move closer to the Fed rate cut decision, and a positively sloped curve historically occurs under such circumstances with a bull-steepening bias as 2-year rates press lower. Furthermore, I expect the steepening of the yield curve to be a consistent theme as we move forward through 2025. Early last week, the rates markets appeared to be in over-bought territory as yields along the entire curve tested levels not seen since Spring of 2023; more on this shortly. On the other hand, as the week progressed, rates generally consolidated as economic data failed to provide a strong incentive for a continued push lower.

The above chart shows the current Implied Fed Funds Target Dot Plot. Note that the 2024 projection is still at 5.125%, and the 2025 year-end is at 4.125%. Fed officials' Dot Plot projections should materially change at Wednesday’s meeting and should significantly impact the Dot Plot picture going forward. The question of a 25 or 50 bp cut by the Fed remains a prominent talking point among economists, strategists, traders, asset managers, and pundits alike. I can respectfully see a case for either outcome; however, I fall firmly into the 25 bp cut camp for several reasons. Before getting into it, however, I must note that there is a distinct difference between some economists calling for a particular rate cut outcome, as opposed to some economists suggesting what is more likely to be the actual outcome. First, the Fed’s more conservative approach to fiscal policy – especially when changing course outside of “emergency” situations leads me to expect a more modest approach for their first cut during this cycle. Furthermore, I believe a stronger 50 bp cut would signal to the market that the economy is on less firm footing and create a more urgent market reaction. Though some may argue the Fed can jaw-bone around this concern, history tells me that the market pays less attention to Fed rhetoric and is more reactive to Fed action. Additionally, CPI and PPI suggest that core-PCE will continue in line with the Fed’s preferred path toward its 2% inflation target. The employment picture, the second part of the Fed’s dual mandate, is arguably more important to determining the Fed’s inclination for fiscal policy at this time. They have been very clear in not desiring to see further cooling of the labor market. Thus, a 25 bp cut seems most in line with the message the Fed has delivered for the past several months.

Ahead of the rate decision, if 10-year rates remain in the consolidation area between 3.60-3.70%, I would expect a modest sell-off and the opportunity for rates to drift higher after announcing a 25 bp cut. Contrarily, if the Fed undertakes a more robust 50 bp cut, this signal to the market should create an aggressive bid in the market, and a strong initial reaction should ensue. Friday's positioning by some traders in anticipation of a 50 bp cut raised the likelihood of such an outcome to 40%. So, at least a portion of a rally on a 50 bp cut may already be priced into the market.

In municipals, investors took a more cautious approach last week, as demonstrated by less money pursuing the longer part of the curve, ratios ticking slightly higher, and deals receiving more “spotty” interest (notably inside 10 years maintained a more consistent level of interest than longer-dated maturities). This week, the new issue calendar is a modest $5.5-ish billion – to be expected during the week of a Fed rate cutting announcement. Issuance should resume its heady pace next week and continue as such through much of October. As the election looms, however, issuers will pare back their funding needs and wait for the dust to clear, as political uncertainty is something investors and issuers both prefer to avoid.

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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