Fed Meeting Key Takeaways
- As expected, the FOMC voted to lower rates by 25bp to a target range of 4%-4.25%, the first cut since last December.
- The updated dot plot median projection shows another 50bp of cuts this year, yet only 25bp in 2026.
- Economic expectations were revised modestly higher for GDP, while unemployment projections were little changed, and inflation estimates were revised modestly higher.
- New Fed Governor Stephen Miran was the lone dissent, in favor of a 50bp cut. Michelle Bowman and Christopher Waller, who had dissented at the last meeting, did not dissent this time.
Our take: The Fed delivered the 25bp cut that most market participants expected, and updated dot plots which suggest another two cuts this year. On the other hand, during his press conference, Jerome Powell suggested that this cut was an ‘insurance cut’ and did not necessarily signal a quick or deep run of future cuts. While they may prove to be necessary, it will remain data dependent. The official FOMC statement downgraded the Fed’s assessment of the labor market, noting that “job gains have slowed, and the unemployment rate has edged up but remains low”, and “downside risks to employment have risen”. At the same time, in a somewhat contradictory note, inflation “has moved up and remains somewhat elevated”. This is the stagflationary dilemma the Fed will continue to face in the months ahead. From a governing standpoint, the fact that Bowman and Waller did not dissent again at this meeting suggests that Chairman Powell remains firmly in control of the committee and can generate consensus, aside from the newly appointed Stephen Miran.
Economic Commentary
- Retail sales rose 0.6% in August and were revised up a tenth to 0.6% in July, marking the first three consecutive monthly increases since December. June sales were revised, too, from 0.6% originally to 0.9% a month ago and 1.0% today. Sales are up 3.5% year-on-year, the most since last January. Control group sales, which feed into GDP, rose 0.7%, beating the consensus forecast of 0.5%. However, retail sales had one of the most aggressive seasonal adjustment factors on record; under a normalized seasonal factor the headline would have shown a -0.5% decline rather than the +0.6% increase.
- According to data recently published by Moody’s, 49.2% of Q2 spending came from the top 10% of the income distribution. This is up from 43.2% right before the pandemic and 35.3% in 1992.
- The Mortgage Bankers Association reported the average 30-yr mortgage rate dropped 10bp last week to 6.39%, lowest since last October. Mortgage applications rose 29.7%, the most since a 33.3% spike in the second week of January this year.
- The preliminary University of Michigan sentiment survey for September showed the overall index fall from 58.2 to 55.4 on Friday. The spike in long-term inflation expectations from 3.4% to 3.9% was notable, but we think the bigger economic implications are in deteriorating job market sentiment. 23.1% of survey respondents estimate their job loss probability within the next five years, matching its highest rate since July 2020.
- Housing starts came in at 1.307 million, below estimates of 1.365 million. Permits also came in below expectations at 1.312 versus 1.370.
- Initial jobless claims dropped from 264k last week to 231k this week, and continuing claims were 1,920k down from 1,927k last week. Both were below expectations and pump the brakes for the moment on a rapidly deteriorating labor market.
Our take: Economic data was mixed over the last week, where indicators driven by lower income consumers continue to show signs of strain, while overall broader statistics offer more resilience and optimism. This is understandable, as lower income consumers are less able to withstand the cumulative effects of inflation on basic necessities, compounded by the restart of student loan payments and a weakening labor market. At the same time, middle and upper income consumers have the benefit of home price appreciation and wealth gains from investment holdings to inspire more confidence. Which direction the labor market and overall economy take from here will largely depend on how companies fare in mitigating tariffs, and how much they may need to offset margin degradation with job cuts.
Corporate Bond Market Commentary
- IG spreads tightened 2bp to +77bp and total returns were +0.55%.
- IG fund flows were +$2.1 billion.
- IG new issue supply was $38 billion, falling short of the $45 – $50 billion estimate. NICs were 1.3bp, book coverage was 3.9x, attrition was 21%, and deals tightened -26bp from IPT to final pricing.
- HY spreads tightened 4bp to +279bp and total returns were +0.27% (BBs +0.41%, Bs +0.28%, CCCs -0.49%).
- HY fund flows were +$1.2 billion.
- HY new issue supply was $9 billion including deals from Hawaiian Electric, K. Hovnanian, Energizer Holdings, NCL Corporation, and Amkor Technology, among others.
Our take: The credit markets remain wide open, allowing companies to refinance upcoming bond maturities, enhance liquidity, and confidently pursue mergers and acquisitions. These animal spirits offer ample opportunity for both trading the new issue market and for finding event-driven or catalyst focused trades. In addition, the refinancing wave is clearing the decks substantially for lower quality borrowers over the next 18 to 24 months, but does not remove default risk entirely, as ample historical data suggests overall debt burdens trigger defaults more often than actual pending maturities.
Municipal Bond Market Commentary
- The muni index returned +1.42% last week.
- Muni yields were -9, -13, -19, and -23 last week and ratios were -3, -4, -4, and -3 to end the week at 56%, 58%, 70%, and 90% at 1, 5, 10, and 30 years respectively.
- State and local government Big 4 tax collections (sales, property, personal income, and corporate income) rose 5% year-over-year.
- New issue volume was $14 billion. This week’s calendar totals $9.1 billion.
- Fund flows were +$2.791 billion, comprised of $823 million into mutual funds and $1.968 billion into ETFs.
Our take: Munis outperformed last week driven by more inflows and manageable new issue supply. Many market strategists expect uneven performance through fall due to elevated supply and fewer reinvestment dollars, but then expect a strong finish to the year given still-cheap long end valuations, an anticipated deceleration in new issuance, and sustained fund inflows with the expected resumption of the Fed easing cycle. While we agree with most of this analysis, we also believe that fund flows could accelerate, driven by retail investors chasing future rate cuts and strong recent performance in the typical muni investor feedback loop. Therefore, any weakness from concerns around supply/demand technicals could be a good opportunity to add exposure, especially at the intermediate and longer part of the curve where ratios are cheaper by historical standards.
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