Economic Commentary
- Jerome Powell’s speech at Jackson Hole made clear the time has come for rate cuts, starting in September. The Fed does not seek or welcome further cooling in labor market conditions. The Fed will be data dependent as to the amount and timing of such rate cuts.
- Consumer confidence rose unexpectedly from 100.3 to 103.3, a six-month high, despite deteriorating views on the labor market, due to more positive sentiment on the economy and inflation. However, this has not been a reliable predictor of economic activity over the last three years.
- Regional manufacturing indices are deteriorating – the Dallas Fed report rose from -17.5 to -9.7 but has been negative since April 2022, Dallas services declined from -0.1 to -7.7, and Richmond Fed declined from -17 to -19.
- Second quarter GDP was revised higher to 3.0%, primarily due to a large upward revision in consumer spending from 2.3% to 2.9%. At the same time, the personal savings rate was revised down from 3.5% to 3.2% (and 3.8% in Q1). Other than a brief stretch in mid-2022, the last time the savings rate was this low was August 2008. Real GDI grew only 1.3%, the same pace as Q1. This is much more consistent with a job market and employee compensation that are cooling. Consumers will have to slow their spending.
Our take: A lot of rate cuts are priced into markets – 4 cuts by year-end 2024 and another 5 in 2025. Based on recent economic data, that seems like too many. However, this is akin to driving by looking in the rearview mirror. What matters is where we are going. With weakening income levels and a low savings rate, combined with a deteriorating view of the labor market, consumer confidence and spending could decline. Recent retailer earnings calls and management commentaries suggest caution is warranted. This would also prompt slower hiring or layoffs to protect profit margins, and the cycle of an economic slowdown would kick in. That is how 9 rate cuts by the end of 2025 become necessary. Add to duration on any backup in rates caused by a few stronger than expected data points.
Corporate Bond Market Commentary
- IG spreads were 2 tighter to +96bp and total returns were +0.73%.
- Year-to-date IG returns are now +4.55%.
- IG fund flows were +$1.332 billion.
- August will be the fourth consecutive month of positive returns for IG bonds, which will help support future fund flows.
- HY spreads were 10bp tighter to +319 and total returns were +0.74%.
- Year-to-date HY returns are now +6.15% driven by CCCs (+9.43%), Bs (+5.83%) and BBs (+5.60%).
- Fund flows into HY were a robust +$1.781 billion.
Our take: August performance has been strong, supported by declining rates and constructive fund flows. After Labor Day, new issue supply will increase substantially, which could put some pressure on existing outstanding bonds and bring price concessions on new ones. We have tactically trimmed some positions into this recent strength, building up a bit of dry powder for any of the compelling new issue deals and also for any cheapening that may occur in existing bonds.
Municipal Bond Market Commentary
- Yields moved lower in US Treasuries and short municipals for the week ending August 23, with longer term muni rates bucking the trend and rising slightly. AAA muni yields were down 16 and 11 bps at 2 and 5 years, and up 3 bps at both 10 and 30 years. The AAA municipal bond curve outperformed US Treasuries on the short end of the curve and lagged on the long end, with US Treasury yields falling 13, 11, 8, and 5 bps at 2, 5, 10 and 30 years.
- AAA Muni/Treasury ratios fell on the short end and rose slightly at the long end, down 2% at 2 years, down 1% at 5 years and up 2% at 10 and 30 years to end the week at 64%, 68%, 71% and 89%. AA Muni/AA Corporate ratios followed a similar pattern, down 3% at 2 years, down 1% at 5 years, up 1% at 10 years and up 2% at 30 years to end the week at 60%, 64%, 67% and 82% at 2, 5, 10 and 30 years.
- For the period ending August 21 municipal bond funds had inflows of $501 million, $432 million to open-end funds and $69 million to ETFs. This was the 8th consecutive week of reported positive flows.
- The muni new issue calendar is expected to be around $9.5 billion.
Our take: No surprises from Chairman Powell in his Jackson Hole speech. This has been a relatively slow week for economic reports, but the Fed’s favorite inflation indicator, PCE, will be released on Friday right before the Labor Day long weekend, and the monthly nonfarm payroll numbers the following Friday. Barring surprisingly strong PCE and payroll numbers, we anticipate a continuation of daily volatility oscillating around a trend line to lower yields.
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