Economic Commentary
- The Congressional Budget Office reported that the deficit for fiscal 2025 was $1.8 trillion, little changed from fiscal 2024. However, the ratio of deficit to GDP declined from 6.4% to 5.9%.
- The minutes from last month’s Fed meeting didn’t provide any major revelations. At the September meeting, the FOMC believed that the balance of risks had shifted slightly towards a cooling labor market, permitting a 25bp cut. One participant favored a 50bp cut, while others “stated there was merit in keeping the federal funds rate unchanged.”
- Cuts to, and uncertainty around, federal funding has been a headwind to private sector hiring. Federal government employment has declined by 97K since January (-3.2%), compared to an increase of 27K during the same period in 2024. A more precipitous drop off is in store for October when roughly 125K deferred resignations will show up in the payrolls data.
- Forward-looking measures of layoff activity are not showing signs of employers capitulating, yet. Challenger job cut announcements have trended higher over the past year, but the pace of growth has slowed more recently, and the latest WARN Act data, which captures the 60-day advance notice required for large layoffs, similarly suggests the pace of discharges has slowed over the past few months.
- The NY Fed 1 year inflation expectations index rose slightly from 3.2% to 3.38%.
- US Services PMI and Composite PMI both rose from last month and came in above expectations, at 53.9 and 53.6 respectively.
Our take: Now that the balance of risks between inflation and employment are not obviously skewed in one direction or the other, the Federal Reserve is facing a difficult task. Recent Fed speakers have been articulating varying points of view on the risk of inflation re-accelerating versus the likelihood of further deterioration of the labor market. Complicating an already-difficult conundrum is the fact that much of the important economic data is not being released during the federal government shutdown. This places additional importance on alternative data sources. There is much discussion about a labor market that is low hiring / low firing. Our view is that wages are the true determinant of how supply and demand for labor interact, and statistics such as average hourly earnings paint a picture that is slowly but steadily declining. It is certainly possible that as uncertainty is abating, and growth is solid, that companies will regain confidence and start hiring again. On the other hand, it is possible that companies in certain sectors that are struggling or that are dependent on federal funding will have no choice but to eventually start laying off workers to protect margins. Markets are currently pricing in 1.8 rate cuts in 2025 and another ~2.5 cuts next year. This feels reasonable given the information available but could easily swing in one direction or another. Even if we do get a series of further rate cuts, the longer end of the yield curve may not follow the front end, so waiting for more clarity before staking out more aggressive duration positioning is prudent.
Corporate Bond Market Commentary
- Investment grade bond spreads were unchanged at +75bp and total returns were +0.54%.
- IG fund flows were +$1.838 billion.
- IG new issuance was only $13.7 billion, well below expectations of $25 billion. Books were 3.5x covered, new issue concessions were 3.9bp, attrition was 28% and deals tightened 28bp on average from initial price talk to final pricing.
- HY bond spreads were +5bp wider to +280bp and total returns were +0.25% (BBs +0.25%, Bs +0.19%, CCCs +0.40%).
- HY fund flows were +$1.214 billion.
- HY new issuance was $11.25 billion last week across 13 deals including Carnival, Transocean, Starwood, Brandywine, Viking Cruises and Waterbridge.
Our take: Corporate bond markets grinded out modest returns last week as fund flows remained supportive and new issue supply calmed down a bit after the deluge in September. The current week has remained relatively quiet for issuance as many companies are in earnings blackouts. Despite the calm, bond prices have been a bit lower this week as some risk aversion seeps in after the high-profile implosions of Tricolor and First Brands. The supportive technicals of lighter supply, favorable fund flows, and coupon reinvestment should provide an underpinning to the market, at least until companies start reporting third quarter earnings. Earnings reports are likely to reflect the strength of third-quarter GDP, though results may vary meaningfully across sectors. Some industries—such as chemicals, freight-related transportation, and subprime consumer finance—face ongoing challenges, while others appear more stable. As this dispersion increases, the opportunity set for active management and fundamental credit picking should increase commensurately.
Municipal Bond Market Commentary
- The municipal bond index returned +0.34% last week.
- Muni yields were +1bp, -1bp, -2bp and -3bp and ratios were +1%, unchanged, unchanged and unchanged to 63%, 61%, 70%, and 89% at 1, 5, 10, and 30 years respectively.
- New issuance was $10.2 billion.
- The preliminary new issue calendar for this week is $14.2 billion.
- Fund flows were strong at +$1.857 billion, split between +$846 million into mutual funds and +$1.01 billion into ETFs.
Our take: In continuation of recent trends, municipal bond market technicals remained supportive where fund flows and coupon reinvestment were sufficient to absorb the new issue calendar. There will inevitably be weeks when the primary market overwhelms investor demand, and others where the calendar is light and secondary municipal bond prices are stronger. This should bring opportunity to add municipal bonds, particularly at the longer end of the maturity curve, for those investors seeking to add exposure in advance of potential additional FOMC rate cuts later this year.
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