The U.S.-Iran conflict is again driving oil prices which, in turn, are driving equity and bond prices. Last Friday, Iran declared the Strait of Hormuz “completely open” causing a surge in the prices of equities and bonds.
“U.S. stocks rocketed higher on Friday after Iran declared the Strait of Hormuz ‘completely open’ on the heels of a ceasefire announcement between Israel and Lebanon.
“The S&P 500 jumped 1.2% to close at 7,126.06, crossing the 7,100 threshold for the first time. The Nasdaq Composite gained 1.52% and settled at 24,468.48 for its 13th consecutive winning day and its longest positive streak since 1992. Both indexes posted fresh intraday and closing records. The Dow Jones Industrial Average jumped 868.71 points, or 1.79%, to end at 49,447.43. The Russell 2000 also reached a fresh high. The small-cap index rose more than 2%.” Head Fake #1
Meanwhile, on Friday, all the supposed good news turned a little murkier.
“Oil prices were mixed Friday as the United States and Iran are expected to hold direct talks in Pakistan.
“International benchmark Brent crude futures closed little changed at $105.33 per barrel, while West Texas Intermediate futures lost more than 1% to $94.40.
“Iran’s foreign minister, Abbas Araghchi, said earlier Friday that he would travel to Islamabad, Muscat and Moscow to ‘closely coordinate with our partners on bilateral matters and consult on regional developments.’” Head Fake #2
And by Saturday morning:
“Stalled peace effort: The White House had hoped to renew peace talks by sending envoys to Islamabad, but Tehran never confirmed plans to meet directly. Iran’s top diplomat left Pakistan following talks with mediators Saturday, saying afterward that Tehran has yet to see if Washington is ‘truly serious about diplomacy.’” Latest Update
With all this volatility, WTI closed on Friday at 94.40, 14.3% higher than the close on April 17. The S&P 500 was 0.55% higher on the week. 10-year Treasury yields were about 5 basis points higher on the week. The military has a term to describe events like these: SNAFU (Situation Normal: All Fouled Up).
The U.S. consumer is not feeling too good. The University of Michigan’s final April consumer sentiment numbers were released this week. The final reading was 49.8, well below the long-term average that CDI calculates as 78.54. For those interested, that is a -2.10 standard deviation event which is very troubling. The old Misery Index (an indicator constructed by using CPI Y/Y for inflation and the unemployment rate), was 7.60 on April 24, approaching the long-term average of 8.34. This reading is 13.4% higher than the 6.7 reading on Feb. 27. The markets’ expectations of a Fed rate cut are very low. No FOMC meeting through July 28 holds an implied rate-cut probability higher than 13.2%.
Kevin Warsh had his day in front of the Senate confirmation committee and it went pretty much as expected. Softball questions by the Republicans on the committee and more “chin music” from the Democrats. Republican Senator Thom Tillis of North Carolina put up hurdles for Warsh’s confirmation; he wants the Department of Justice’s investigation of Chair Powell dropped:
“His frustration wasn’t with Warsh. ‘You have extraordinary credentials. They’re impeccable,’ Tillis told him. ‘Let’s get rid of this investigation, so I can support your confirmation.’” Seems like a simple, straightforward plan?
U.S. Attorney for the District of Columbia Jeanine Pirro looked like she was going to comply with Sen. Tillis. That is, with one caveat:
“After the inspector general completes his report, Pirro said her office will review it and could restart its criminal probe if warranted.” Maybe not that straightforward.
The option Pirro referenced makes it very hard to price for Sen. Tillis. It involves a great deal of trust, which seems to be in short supply in Washington (now more than ever).
On Sunday morning’s edition of “Meet the Press” Sen. Tillis said that after more clarification from the DOJ he would vote to confirm Warsh.
“Sen. Thom Tillis, R-N.C., on Sunday said he'll vote to confirm President Donald Trump's nominee to lead the Federal Reserve, Kevin Warsh.” Last Hurdle Cleared
Kevin Warsh also favors a different inflation measure than current Fed-favorite core PCE.
“‘The measures I prefer are looking at things that are called trimmed averages,’ Warsh added. ‘We take out all of the tail-risks, all of the one-off items, and we ask ourselves whether the generalized change in prices is having second-order effects on the economy.’” Shopping for the best measure?
“Warsh said that the current underlying trend of inflation is ‘somewhat improving’ and looks ‘quite favorable’ when examining so-called trimmed measures of inflation. The Dallas Fed trimmed mean PCE is currently 2.3%, while the Cleveland Fed median PCE is 2.8%. — both lower than the latest reading of core PCE, which is at 3% and expected to increase. Pick what best supports your argument
There will be a Fed meeting this week, which will probably be Powell’s last as chair. The Fed is expected to hold rates steady given all the volatility in the world. What Powell plans to do after Warsh’s confirmation is still unknown. CDI suspects he will do what is best for the institution (in his view).
CHANGES IN RATES
TreasuryMarket
Treasury yields moved higher throughout the week. The 2/10 spread narrowed to approximately 53 basis points (from roughly 55 basis points last week).
Municipal Market
AAA general obligation municipal bond yields were flat on the week. The 2/10 spread was 56 basis points, down from 59 basis points a week ago.
Selected Municipal AAA General Obligation Bond / Selected Treasury Bonds Yield Ratio
The 1-10-year ratios are really compressed and historically rich. Treasuries sold off harder than munis in the front end this week. Municipal bonds 10 years and shorter are rich by historical standards. The muni /Treasury ratios are through the current breakeven rate of 67% (highest marginal tax rate).
Investment Grade Corporates
IG Corp yield drifted higher this week following the Treasury market and the price of oil.
The biggest news out of Washington centered around the Warsh confirmation hearings. As of Sunday morning, Warsh looks to be moving forward. What does Warsh’s appointment mean for interest rates and the yield curve?
“Warsh has called for the Fed to further reduce the size of its balance sheet through asset sales. The net impact should be to reduce the growth of the money supply, which would be disinflationary. In addition, a sale of government bonds would likely lead to higher bond yields.” What the future may hold
CDI believes that the president’s focus on short-term interest rates and Warsh’s focus on the Fed’s balance sheet will lead to lower short-term rates, even though the market’s implied probabilities do not support this view. In addition to this balance sheet view, the long-term financing needs of the U.S. deficits will lead to higher long-term interest rates. Commonly referred to as a bear steepener.
The other big story this weekend was the shooting at the White House Correspondents’ Association dinner. We were all set to report on the dinner — lovingly and commonly referred to as “Nerd Prom” — with some snarky commentary. But the attempted attack by a potential political assassin makes that plan feel very out of place. No matter your political affiliation, the fact that all attendees are safe is a triumph.
Finally, the do-nothing Congress will have to grapple with the War Powers Resolution of 1973:
“Under the War Powers Resolution of 1973, the president must terminate the use of armed forces after 60 days unless Congress authorizes military action, though the president could request a 30-day extension to ensure the safe withdrawal of troops and the extra time is not meant to continue combat operations.” To do (nothing) or not to do (nothing): questions facing Congress.
We suspect that Congress will find a way to do nothing.
The 5-year Breakeven Inflation Rate finished the week of April 24 at 2.61%, 5 basis points higher than April 17. The graph above contrasts a 5-year Breakeven Inflation Rate tracked weekly. This is the market implied inflation rate. We track this relative to core PCE, the Fed’s favorite inflation measure. The 10-year Breakeven Inflation Rate finished the period at 2.42%, 6 basis points higher than last week.
Last week's 10-year quality credit spread between BBB revenue bonds and AAA general obligation bonds was 0.83%, higher on the week by 4 basis points. The historical average credit spread is 1.68%.
Investment-grade spreads for the past week were at 101 basis points, unchanged from the previous week. The long-term average for investment grade is 1.56%. High-yield credit spreads are 2.68%, higher than last week by 9 basis points.
Money Market Flows (millions of dollars)
Money market fund flows were negative across almost all categories.
Mutual Fund Flows (millions of dollars)
Mutual fund flows were positive overall.
ETF Fund Flows (millions of dollars)
Net ETF flows were negative in all categories.
This week, the supply of new-issue municipal bonds is estimated at around $7.3 billion. This should be a manageable amount.
Volatility is reigning in the short run driven by the Iran conflict. In addition to that we look forward to having a new Fed chair confirmed. What that holds for the fixed-income markets is a wild card. The history of this administration’s nominees is that confirmation testimony does not really reflect their action once in their position. The short end of the municipal bond market looks a little expensive but that can change on a dime with a large new-issue supply calendar.
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