Economic Commentary
- Q3 GDP rose at a 2.8% annualized rate, marginally below the consensus, 2.9%. The core PCE deflator rose at a 2.2% rate, slightly above the consensus, 2.1%. The 2.2% increase in the core PCE deflator in Q3, meanwhile, implies a 0.34% increase in September, assuming no revisions to July and August.
- Treasury’s quarterly refunding announcement went as expected. Coupon auction sizes will remain unchanged from the previous three months and they expect no change for “at least the next several quarters.” This calms one of the fears of investors around potential increases in US Treasury bond supply.
- September’s personal income and spending data cast further doubt over the sustainability of recent rapid GDP growth. Annualized growth in real after-tax income over the last three months, compared to the previous three months, slowed to just 1.6% in September, from 2.0% in August. Accordingly, households have continued to fund rapid growth in real expenditure by reducing their saving rate, which dipped to 4.6% in September from 4.8% in August, and is now well below its 2015-to-19 average, 6.1%. Admittedly, a period of below-normal saving was warranted following the pandemic. But the saving rate now looks low, given that the ratio of households’ liquid assets has returned to its pre-Covid trend level, and the labor market is deteriorating. A stable saving rate next year is a solid bet, with the risks skewed towards an increase.
- The ECI report brought good news for the Fed, which focuses on this measure of labor costs because it is mix-adjusted. The 0.8% quarter-on-quarter increase in workers’ total compensation in Q3 reduced the year-over-year rate to 3.9%—the first sub-4% figure for three years—from 4.1% in Q2. Recent solid growth in productivity means that labor costs already are rising slowly enough for core PCE inflation to fully return to the Fed’s 2% target. The low level of the quits rate and the job postings-to-unemployment ratio suggest that growth in ECI private wages and salaries will continue to slow, increasing the risks of a period of below 2% core PCE inflation next year.
Our take: The lazy take on current economic activity is to simply look at popular headline economic figures – GDP, jobless claims, etc. If one digs a little deeper, more relevant and substantive indicators suggest labor costs have moderated to levels consistent with 2% inflation, and recent economic strength has been driven by consumers spending beyond their means. The low savings rate is unsustainable; perhaps people were excited about the prospects of lower interest rates and animal spirits took over, with consumers expecting cheaper borrowing getting out ahead of that and starting to spend. If so, the recent significant rise in rates might beget some regrets. We may not be heading for an imminent hard landing, but moderating labor costs should embolden the Fed to continue on a gradual path of rate cuts to try and offset the inevitable pullback in consumer spending.
Corporate Bond Market Commentary
- IG spreads widened 2bp to +85bp and total returns were -1.02%.
- Fund flows were -$396 million.
- New issue supply was only $12.1 billion.
- HY spreads widened 1bp to +289bp and total returns were -0.39% (BBs -0.43%, Bs -0.38%, CCCs -0.28%).
- Fund flows were -$404 million.
- New issue supply was $6.2 billion.
Our take: CCCs had their first weekly loss in four months, a pretty remarkable streak. All of high yield has compressed and spreads are very tight by historical standards. Much like the equity market that it correlates highly with, valuations are stretched but the market keeps pressing higher. It would not require a recession to cause a pullback here – anything other than a no-landing or very mild one, an unexpected outcome in the elections, or a further reversal higher in UST rates could all be a catalyst for a draw-down; of course it is usually the culprit that no one could predict that tips things over. The risk reward is better in higher quality bonds, especially given that the recent sharp move higher in rates has pushed all-in yields back to more compelling levels.
Municipal Bond Market Commentary
- US Treasury and muni yields resumed their upward move for the week ending October 25. AAA muni yields were up 16, 22, 27, and 20 bp at 2, 5, 10 and 30 years while US Treasury yields were up 16, 19, 16, and 11 bp at 2, 5, 10 and 30 years.
- Muni bonds underperformed Treasuries, moving AAA Muni/Treasury ratios higher by 2% at 2 and 5 years, 4% at 10 years and 3% at 30 years to end the week at 65%, 66%, 71% and 86%. AA Muni/AA Corporate ratios were up 2% at 2 years, 3% at 5 and 10 years, and were unchanged at 30 years to end the week at 66%, 65%, 67% and 78% at 2, 5, 10 and 30 years.
- For the period ending October 23 municipal bond funds had inflows of $514 million, the 17th consecutive week of reported inflows.
- Another large muni new issue calendar, expected to be $10.3 billion this week
Our take: No real change in our outlook this week as 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. At this point the speed of FOMC rate cuts may be debated and it could be questioned whether the first cut should have been 25 or 50 bps, but there has yet to be any data so strong as to cause the FOMC to second guess the cutting cycle. The upcoming nonfarm payroll report, the election, and the November FOMC meeting all have the potential to move markets significantly. Though moderated by fund inflows, municipal bonds are being pressured by supply/demand technicals, with high volumes of new issuance supply coming to market as dealers report buyers are becoming tentative in the secondary market and bid wanted volumes are growing.
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