Economic Commentary
- In his speech at Jackson Hole, Kevin Warsh made several key points:
- The Fed’s focus is on the PCE deflator as its inflation measure. Because core PCE inflation is rising this year, while core CPI inflation is falling, the divergence between these inflation measures makes it much more likely the Fed will hike.
- While acknowledging that this summer’s PCE and CPI readings were better than expected, Warsh said they did not show that underlying inflation trends had “meaningfully improved”. His standard is that the Fed must be confident inflation is moving towards 2% both clearly and “at sufficient speed”…otherwise, “we have work to do”.
- Warsh also dismissed moderate wage growth as a reliable leading indicator of inflation and instead focused on the breadth of price increases across the 199 components of PCE. Some 54% have risen by more than 3% over the past year, down from the post-pandemic peak of around 77% but still well above the pre-pandemic average of 32%. Over the past six months, the equivalent share remains at 49%. The choice to emphasize both six- and twelve-month breadth suggests he is looking through the better recent prints rather than treating them as sufficient evidence of disinflation.
- The August ISM manufacturing index fell from 55.6 to 54.6, missing estimates for a decline to 55.2. New orders fell three points to 53.7, and employment fell from 52.8 to 51.2. Prices paid were unchanged at a very high 71.1, likely driven by elevated prices for oil, gas, and diesel.
- The July JOLTS report showed fewer job openings than expected – 7.27 million – with a downward revision to June from 7.36 million to 7.18 million. Job openings have stabilized just above 7 million, solidly within pre-pandemic averages, suggesting labor demand is stable but cool.
- Treasury Secretary Scott Bessent said high yields were the result of war-driven inflation concerns that will soon subside, and that the path towards fiscal improvement in the US is through strong economic growth.
- The 1-year inflation expectations component of the August U Mich survey was revised down from 4.4% to 4.0%.
- Unit labor costs rose 1.2% in Q2, down from 1.3% last quarter and below estimates of 1.3%, in another sign that the labor market does not appear to be a source of inflation.
our Take
Fed Chair Kevin Warsh’s Jackson Hole speech was a clear hawkish pivot, reversing some of the market’s post-July FOMC press conference concerns and credibility questions. Bond markets are now pricing in a 62% probability of a hike in September, and approximately 2.5 hikes in total by next summer. Next week when everyone is back in their seats and trading liquidity improves, we will see if this credibility can withstand the wave of expected corporate bond issuance, especially at the long end of the curve.
Corporate Bond Market Commentary
- Investment grade bond spreads tightened 2bp to +79bp and total returns were +0.30%.
- IG new issue supply was $6 billion last week, and NICs were 5.3bp, books were 3.5x covered, attrition was 11%, and deals were tightened 24bp on average from IPT to final pricing.
- IG fund flows were +$906.7 million.
- High yield bond spreads tightened 10bp to +260bp and total returns were +0.27% (BBs +0.22%, Bs +0.33%, CCCs +0.44%).
- There was no HY bond issuance last week, and none expected this week either.
- HY fund flows were -$1.52 billion.
Our Take
Two things worth watching closely in the week ahead are investment grade supply and high yield fund flows. After Labor Day, a surge in IG supply is expected, which could put pressure on spreads and longer-term US treasuries. While high yield bond issuance should also come back to life, whether last week’s large outflow continues into further outflows might be more impactful on near-term performance.
Municipal Bond Market Commentary
- The municipal bond index returned -0.15% last week, the third down week in a row.
- Muni yields were -1, -1, +1, and +3, and ratios were -2%, -1%, unchanged, and +1% to 58%, 63%, 70%, and 87% at 1, 5, 10, and 30 years respectively.
- Last week’s new issue volume was $15.2 billion, of which $11.4 billion was tax-exempt. This week’s new issue calendar totals $16 billion, of which $13.9 billion is tax-exempt. Next week’s calendar already totals $10.5 billion.
- Fund flows were +$1.645 billion, including $233 million into mutual funds and $1.412 billion into ETFs.
Our Take
Municipal bond supply did not take the late August hiatus that the corporate bond market did, but fund flows and August 15th reinvestment dollars were reasonable support. Going forward, supply should pick up while reinvestment dollars are lower over the next few months. Fund flows tend to follow performance, so if three negative return weeks in a row do not stabilize and reverse soon, a pullback in muni fund flows would complicate an already weakening net supply picture over the coming months.
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