Fixed income markets were battered last week in a fitting prelude to the nor'easter that swept across much of the Northeast coastline over the weekend. While the storm's immediate impacts included power outages, coastal flooding, and widespread disruption to daily life, the forces unsettling financial markets appear likely to be far more persistent.
Futures now imply the possibility of as many as four additional rate hikes before the terminal Fed Funds target is reached. More importantly, investors are increasingly concerned that inflation is no longer being sustained solely by supply-side disruptions stemming from the conflict with Iran. Instead, evidence is mounting that stronger demand may now be contributing to upward price pressures, a dynamic that is typically more difficult for policymakers to contain.
Once that level is reached, the natural question becomes what comes next. From a technical perspective, the next meaningful targets lie near 5.40%, followed by the 2001 high of approximately 5.53%. Until there is convincing evidence that inflationary pressures are beginning to moderate, or that economic activity is slowing sufficiently to alter the policy outlook, I see little reason to expect the prevailing upward trend in rates to reverse. Much like the nor'easter that lingered longer and proved stronger than many expected, the forces driving rates higher continue to intensify, suggesting the storm for fixed income markets is not yet over.
Contributions from Ryan Riffe
The municipal bond market selloff intensified this week as renewed inflation concerns and stronger-than-expected midweek PMI data pushed rates sharply higher across the curve. By Friday's close, benchmark yields in the 1-3 year segment had risen by as much as 48 basis points, while intermediate and long-term maturities moved up nearly 30 basis points.
Pressure on municipals has been building since mid-summer as Treasury yields surged higher amid a relentless calendar of new issuance.
The combination of rising underlying rates, heavy issuance, and forced selling created a particularly challenging backdrop for municipal investors.
The market will now turn its attention to approximately $11 billion of new issue supply scheduled for next week, closing out what has been a particularly volatile and difficult September. With Treasury yields continuing to press higher and inflation concerns resurfacing, the municipal market remains firmly at the mercy of the broader rates environment.
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