A lighter economic data calendar last week opened the door for the market to focus its attention on the larger-than-usual amount of Fed-speak. As should have been expected, policymaker opinions covere...
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5 min read
A lighter economic data calendar last week opened the door for the market to focus its attention on the larger-than-usual amount of Fed-speak. As should have been expected, policymaker opinions covered the spectrum from quite dovish to modestly hawkish. Newly appointed Governor Stephen Miran expressed his opinion that a more proactive and larger rate-cutting cycle is preferred. Several of his counterparts countered with a more cautious approach toward future rate cuts. Goolsbee specifically warned about the threat of stagflation, and the prolonged period (over the past 4 ½ years) of above-target inflation warrants a more reserved approach. The most interesting twist came from Logan (non-voter) calling for the Committee to shift their approach from targeting a given level for the Fed Funds Target Rate to instead control the trading level of the Tri-Party General Collateral rate (TGCR). The robust market-based nature of this rate, which is an overnight secured funding rate between dealers and customers in the tri-party repo market, provides a reasonable rationale for her suggestion. It will be interesting if such a measure is adopted and how a more modern approach to fiscal policy plays out as time progresses. On another note, concerns about a possible government shutdown and implications for the employment market and economic growth have started to make headlines. Hopefully, an extended shutdown can be averted, as estimates from previous shutdowns indicate GDP growth is lowered by 0.1 to 0.2 percentage points for each week one persists.
The equity market set a new high at the beginning of last week to settle lower by Friday’s close – the S&P 500 peaked at 6699 on Tuesday. Exuberance in stocks with the expectation of continued stimulus by the Fed does not appear to be ready to wane despite warnings from some economists, as well as Chair Powell justifiably stating that stocks are “fairly highly valued.” Though I caution that a modest pullback in equity prices could be reasonably expected, the market can remain elevated for much longer than my patience may be able to last in waiting for an adjustment to occur.
Treasuries continued to retrace to higher levels following a rejection of the 4% threshold for 10-Yr Notes from the previous week. As demonstrated in the above chart, yields are slightly above the midpoint of their recent downward trend. Additionally, as noted in the chart, targets of resistance at higher yields suggest an initial level of 4.25% and a more important level near 4.33%. Technical indicators point to the opportunity for traders to lock in profits at these higher yields on shorts or hedges established when sub-4% rates were rejected. I continue to propose that the ongoing reluctance of a meaningful number of Fed officials to accept that inflationary pressures are no longer a concern may limit the aggressiveness of future rate cuts below the forecasted 3.25% to 3.50% range at the end of next year. Thus, the normal and upward sloping yield curve would have a natural limitation preventing 2-Yr yields from maintaining lower than 3.50% yields and 10-Yr yields from maintaining much lower than 4% yields. That is not to say that such lower levels cannot be visited, as they were earlier this year following President Trump’s Liberation Day announcement; however, it will be hard to sustain such levels. Thus, I expect to target any moves to such extremes as a good area to fade the market, establish some shorts or hedges, and monetize an eventual back-up in rates from such overbought rates. One final note worth mentioning is that 30-Year mortgage rates have followed the drift lower in 10-Year Treasuries and touched as low as 6.25%. Though a positive for the struggling housing market, providing a 40% increase in applications, it is worth mentioning that the increase is off very low levels and still nowhere near a “normal” amount of activity that was the norm before the Covid-19 pandemic led boom.
From the Municipal Desk (with contributions from Ryan Riffe):
The municipal market experienced its first consequential stretch of weakness last week in nearly a month. Such a move was largely anticipated given the challenges at hand, including a surge in new issue supply to $16 billion (up from $5 billion), seasonal headwinds, and historically expensive ratios for certain parts of the curve. Additionally, the aforementioned jump in Treasury rates provided ample reason for municipal yields to follow suit and rise in concert with their federal counterparts. Yields rose by as much as 26 basis points. The most pronounced movements occurred in the front end, specifically for maturities ranging between 1 and 3 years. The front end had been trading at historically rich levels, with ratios dipping as low as 56%, making a pullback both expected and necessary. Looking ahead, the market is set to digest approximately $8 billion in new issue supply. The lighter calendar, combined with reinvestment flows tied to October 1st, should offer some support and act as a backstop for the market. Despite this, we believe investors should continue to be cautious, especially inside 5-year maturities, where the market seems to be most volatile and still finding its footing. Investors should remain selective and patient as valuations recalibrate.
30-Day Visible Supply @ $15.1 Billion
Weekly Calendar expected @ $8 Billion
2-YR Ratio @ 60%
3-YR Ratio @ 60%
5-YR Ratio @ 60%
10-YR Ratio @ 70%
30-YR Ratio @ 90%
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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