Economic Commentary
- The September employment report was stronger than expected and bond yields spiked in reaction. September nonfarm payrolls rose 254,000, about a hundred thousand more than expected and the biggest increase since the 310,000 rise in March. The net revision to the prior two months was up 72,000, marking the first time since last spring there was no sizable downward revision. July was revised up 55,000 from 89,000 to 144,000 and August up 17,000 from 142,000 to 159,000. Capping the upside surprises, the unemployment rate fell from 4.2% to 4.1%, and actually had to be rounded up to that from 4.051%.
- Fed minutes were largely unsurprising. There was debate within the FOMC about the appropriate size of the first rate cut: “A substantial majority of participants supported” the 50bp cut while “some participants observed that they would have preferred a 25 basis point reduction.” There is consensus that the labor market is cooling and risks to price stability have diminished, although inflation is still elevated. “A few participants” felt a smaller 25bp cut “could signal a more predictable path of policy normalization.” That might be interpreted as a suggestion that future 50bp cuts are highly unlikely, but “a few” means the majority do not necessarily feel inclined to commit to a gradual path of incremental easing.
- September CPI rose +0.2%, above the consensus of +0.1%, and core CPI increased +0.3%, above the consensus of +0.2%. The pick-up was driven by components that are often volatile and do not influence the core PCE deflator, such as airline fares and auto insurance. In addition, improvements in primary rent and Owners Equivalent Rent bode well for future cooling of core services prices and the inflation outlook overall.
Our take: The jobs report last Friday is causing a complete re-think by the markets as to the path of rate cuts and the economy overall. While the report was strong, there are enough other data points on slowing in the labor market (low quits rate, soft ISM labor components, rising number of states showing increases in unemployment claims, declining ratio of jobs available per job seeker, etc) that suggest we should not over-rely on one report. The birth-death model and a massive seasonal adjustment in the calculations could be behind some anomalies. Given the uncertainties, we have adjusted to a bit more neutral positioning and also have increased our cash balances while we await a bit more clarity on the future direction of rates, labor markets, and the economy overall. This positioning also allows us to wait for better directionality now that the Fed Minutes have underscored how the market is aligned with the Fed, meaning the Fed no longer must change its forecast to justify market interest rates.
Corporate Bond Market Commentary
- IG spreads tightened 5bp to +87bp but higher UST rates pushed total returns down -1.03%.
- Fund flows into IG were +823 million.
- New issue supply was $15.5 billion.
- HY spreads tightened 25bp to +289bp, levels last seen in July 2007. Total returns were -0.16% (BBs -0.26%, Bs -0.13%, CCCs +0.19%).
- Fund flows into HY were +$2.854 billion, but have reversed to outflows this week.
- New issuance was $4.8 billion.
Our take: The recent move higher in rates has put a dent into IG and BB returns but has pushed the all-in yields on these bonds back to more compelling levels. On the other hand, spread tightening in Bs and performing CCCs make them less interesting generally. As interest rates stabilize again in this current range, higher quality IG and BB bonds should be bought, along with selective CCCs and special situations who will benefit from the wide-open capital markets and deferred, if not derailed, hard landing.
Municipal Bond Market Commentary
- The selloff in US Treasuries that began in mid-September accelerated, but municipal bond yields only rose slightly for the week ending October 4. Municipal bonds outperformed as AAA muni yields were up 3, 1, 0, and 4 bp at 2, 5, 10 and 30 years while US Treasury yields were up 36, 30, 22, and 15 bp at 2, 5, 10 and 30 years.
- The substantial muni outperformance led to richer AAA Muni/Treasury ratios, which fell 5%, 5%, 4% and 1% to end the week at 62%, 63%, 66% and 85%. AA Muni/AA Corporate ratios were also down 3%, 4%, 4% and 1% to end the week at 61%, 60%, 63% and 79% at 2, 5, 10 and 30 years.
- For the period ending October 2 municipal bond funds had inflows of $1.88 billion, the 14th consecutive week of reported inflows.
- The muni new issue calendar is expected to be around $5.8 billion this week.
Our take: Fixed income markets continue to watch economic numbers, especially those related to employment and inflation, trying to divine signs of economic slowdown and the timing of future Fed rate cuts now that the easing cycle has begun. This week the stronger than expected ISM Services and ISM Prices Paid, followed by a stronger than expected Nonfarm Payrolls number pushed the entire Treasury curve to higher yields. At this point the speed of FOMC rate cuts may be debated but there hasn’t been any data that would cause the FOMC to second guess the cutting cycle. Municipal bonds will look to the Treasury market and municipal supply/demand technicals with the next several months expected to bring higher than normal municipal issuance as issuers weigh the potential impacts of the November elections. Recent municipal fund inflows continue to be very strong and are likely to continue as economic slowdowns have historically let to greater municipal fund inflows.
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