Economic Commentary
- Jerome Powell will speak at 10am on Friday at the Fed’s Jackson Hole conference. The topic of the conference is ‘Labor Markets in Transition: Demographics, Productivity, and Macroeconomic Policy’.
- FOMC minutes from the July meeting read hawkish. A majority of the FOMC was more worried about inflation than the labor market. Note that this meeting occurred before the big downward payroll revisions, but the starting point was more hawkish than the markets understood on July 31.
- Import prices were higher than expected at +0.4% m/m, which would suggest that there is further inflation pressure in the pipeline.
- Foreign investor holdings of USTs climbed to a record high in June, up $80.2 billion from May, in another sign that a large-scale revolt against holding USTs has not materialized yet.
- Retail sales grew +0.5% in July, slightly below expectations of a +0.6% increase. Control group sales also rose +0.5%.
- Standard & Poor’s credits tariff revenue, running at a $300 billion-$400 billion pace, with “softening the blow” to US fiscal health from tax cuts and Congress’s inability to cut spending to offset it, thus preserving the country’s AA+ bond rating. At the current rate of spending and with two months left in the fiscal year, the deficit will be $1.9 trillion this year and $1.7 trillion next year, down from the peak of $2.14 trillion in February.
- The Administration is pressuring Fed Governor Lisa Cook to resign over potential mortgage fraud, in another attempt to assert control over the Fed and pressure the FOMC to lower interest rates.
- Initial jobless claims rose to 235k from 224k, and continuing claims were 1.972 million, up from 1.942 million last week.
Our take: A lot is riding on Jerome Powell’s speech tomorrow morning at Jackson Hole. There is tremendous pressure being applied to him and the Fed to lower rates early and often, at the same time that the data is ambiguous and changing rapidly. Markets are currently pricing in only a 75% probability of a cut in September, down from over 97% earlier this month, and less than 2 cuts this year, down from ~2.5. There are many possibilities as to how economic data, interest rates, fiscal policy, and the future composition of the FOMC could play out, and therefore staking out a definitive risk position is difficult. While rates have remained fairly rangebound for months, there is no certainty they will remain contained. Our approach has been to favor the intermediate part of the curve, coupled with some hedges that would cushion the blow if markets push longer term rates higher.
Corporate Bond Market Commentary
- IG spreads were 5bp tighter to +75bp and total returns were +0.18%.
- IG inflows were $2.51 billion and have reached $31.8 billion on a trailing four-week basis, the strongest pace of inflows since August 2020.
- IG new issue supply was $31.2 billion across 26 issuers, shy of the $40-50 billion estimate. NICs were 1bp, books were 4.2x subscribed, attrition was 22%, and spreads compressed 28bp from IPT to final pricing.
- HY spreads were 6bp tighter to +288bp and total returns were +0.25% (BBs +0.26%, Bs +0.22%, CCCs +0.33%).
- HY inflows were only $138 million.
- New issue supply was $9.45 billion, led by deals from Block, Transdigm, Wynn Macao and Novelis.
Our take: With about 90% of HY companies reporting earnings, this remains the strongest earnings season in two years, according to JP Morgan. However, much of this is already priced into spreads that are hovering around cycle tights. We are now in the August doldrums, which will then lead into the post-Labor Day wake-up call and reassessment. HY ETFs have had outflows for 5 consecutive days, and bond prices are drifting amidst the lackluster trading volumes. Maintaining a cash balance as dry powder to put to work if suitable bargains emerge and adding hedges to help protect against a possible negative ‘a-ha moment’ when traders return from summer and reassess their portfolios with a clearer head, may be a prudent approach. In the IG market, spreads have been at their tightest since May 1998; however, the quality composition of the index is worse today, as BBBs are 46% of the index versus only 26% in May 1998, and duration is 6.8 versus 6.0 back then. Complacency persists in this market much as it does in other risk markets. Hedges on the CDX IG index can offer protection on a compelling risk-adjusted basis.
Municipal Bond Market Commentary
- The muni index posted a slightly positive total return of +.03% last week.
- Ratios were -1, 0, -1, and -1 to end the week at 56%, 62%, 73%, and 93% at 1/5/10/30 years respectively.
- New issue supply was $15 billion, and expectations for this week are $10.3 billion.
- Fund flows turned negative at -$108 million, with short term funds showing +$187 million while long term funds were -$323 million.
Our take: Long-end muni yields remain attractive on both an absolute and relative value basis. Issuance at the longer end is expected to decelerate in Q4, which will help counteract the less-favorable seasonal principal and interest reinvestment dollars. The Fed may resume the easing cycle, which may also support fund inflows and propagate the performance > inflows > performance cycle. Adding a bit of longer-term high-quality municipals may be appropriate in a diversified approach, while retaining flexibility for potential FOMC-induced rate volatility reappear.
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