Let’s start with the elephant in the room. The United States along with Isreal began a bombing operation against Iran on Feb. 28. The administration has referred to the situation as a war. But the Constitution clearly delineates that only Congress can declare a state of war (although Congress has not declared war since WWII).
“‘The Constitution gives war powers to two different branches of government,’ said military historian Peter Mansoor, an Ohio State University professor and retired U.S. Army colonel. ‘The pendulum has swung towards the executive,’ he lamented, arguing that ‘the framers meant for Congress to be the most powerful branch.’” WAR what is it good for?
This intervention has had a negative impact on both the equity and fixed-income markets. The S&P 500 is down 138.86 points (-2.02%) and the 10-year U.S. Treasury note is up almost 0.20% in yield since close on Feb. 27. (If bond yields increase, their price decreases.) Big moves in both markets — and in the same direction.
WTI oil futures have been on a tear. As of March 6, prices were $90.90 per barrel. Compare that to $67.02 per barrel on Feb. 27.
The main drivers of these reactions are the market’s fear that the risks of inflation are increasing while risks of a slowing economy are also increasing. That is called a “stagflation” scenario. In our view, the risks of the Iran incursion are twofold:
Whispers of mission creep are already beginning.
“President Donald Trump has privately expressed serious interest in deploying U.S. troops on the ground inside of Iran, according to two U.S. officials, a former U.S. official and another person with knowledge of the conversations. So Soon
The administration’s goals and objectives have not been made clear to either the American public or to Congress. Public opinion is not supportive of the administration’s actions.
“Fifty-four percent of voters disapprove of Trump’s handling of Iran, compared with 41% who approve and 5% who say they either don’t have an opinion or aren’t sure. A similar share, 52%, say the U.S. should not have taken the military action, while 41% say it should have and 7% say they aren’t sure.” What do Americans Think?
If the incursion continues, these numbers should only get worse. Public support is very important to any military operation. Abraham Lincoln is quoted as saying:
If the incursion continues, these numbers should only get worse. Public support is very important to any military operation. Abraham Lincoln is quoted as saying:
“In this age, in this country, public sentiment is everything. With it, nothing can fail; against it, nothing can succeed. Whoever molds public sentiment goes deeper than he who enacts statutes or pronounces judicial decisions.” Lincoln
Enough with the Iran incursion. Let’s focus on this week’s economic releases (which are all for pre-incursion periods). The big release was Friday’s jobs numbers, but we will sample some earlier economic releases.
We view these releases as somewhat concerning and mildly inflationary. The job numbers caught everyone by surprise on Friday, but the fixed-income market’s reaction has been muted compared to the equity market’s reaction. One can only surmise that inflation fears trump growth fears. (Sorry. Bad pun.) The Atlanta Fed, publisher of the GNPNOW forecast, recast its Q1 GDP estimate to 2.1% (as of March 6) from 3.0% on March 2. GDPNOW
What does this mean for interest rates? Well, on Jan. 30, Bloomberg put the probability of a 0.25% cut in the Fed funds rate at the June meeting (the first without Powell as Chair) at 50.7%. On Friday, that probability was down around 33.2%. It is safe to say that the Fed’s job has gotten tougher. San Francisco Fed President Mary Daly echoed our observations:
“‘This jobs market report has got my attention,’ she said during a ‘Squawk Box’ interview. ‘I don’t think you can look through this report, but I also don’t think you should make more of it than one month of data.’” Mary Daly
Next week we get two inflation reads: more jobs numbers and consumer sentiment indications. Interesting times.
TreasuryMarket
Throughout the week, the Treasury market endured a yield rally (i.e., yields rising). The most significant increases were for maturities of five years and longer. Both the two-year and ten-year yields increased by 0.18%. The 2/10 spread was unchanged at 0.59%.
Municipal Market
The drums of war (or at least the drums of “incursion”) have both the municipal and Treasury markets dancing to the same tune. Both markets’ yields increased across the yield curve by similar magnitudes. The 2/10 spread for last week is at 51 basis points, 5 basis points higher than the week before.
Selected Municipal AAA General Obligation Bond / Selected Treasury Bonds Yield Ratio
Treasury-muni ratios widened across the yield curve.
Investment Grade Corporates
Investment-grade corporate bond yields increased along the yield curve.
Aside from the Iran incursion, the big news coming out of Washington was at the DHS:
“Kristi Noem, the former South Dakota congresswoman and governor who has led President Donald Trump’s Department of Homeland Security in his second term, was ousted from her position on Thursday.” Karma, you know what it is!
We have been thinking of the U.S. debt recently. What actions will drive it higher and therefore increase U.S. borrowing? The cost of the SCOTUS’s tariff ruling has the potential to have a significant impact on U.S. debt. The ruling left the question of refunds unanswered. Lawsuits have already started. For the moment let’s not concern ourselves about who gets the refunds and more on what will refunds do to the U.S. budget.
“The federal government is estimated to owe American businesses up to $175 billion in tariff refunds after the Supreme Court struck down much of the Trump administration's import duties last month. But the U.S. could end up owing considerably more money, according to a new analysis — in interest payments.“ Cost of Tariff refunds
Next up is the cost of the Iran incursion. This is a variable cost which will increase with time:
“The war is costing about $891.4 million per day, according to a think tank based in Washington, DC, that analyzed the information the Pentagon has shared about targets it struck and the assets involved in the operation.” War is not cheap
And that estimate may be on the low side — a pretty bold expenditure for a debtor nation.
The 5-year Breakeven Inflation Rate finished the week of March 6 at 2.56%, 16 basis points higher than last week. The 10-year Breakeven Inflation Rate finished the period at 2.35%, 10 basis points higher than last week.
Last week's 10-year quality credit spread between BBB revenue bonds and AAA general obligation bonds was lower by 7 basis points for the week at 0.85%. The historical average credit spread is at 1.68%.
Investment grade spreads for the past week were at 106 basis points, 2 basis points lower than the previous week. The long-term average for investment-grade is 1.56%.
Private credit is making headlines again this week:
“BlackRock BLK -7.13%decrease; red down pointing triangle limited withdrawals for the first time from one of its flagship private-credit funds, marking the latest sign of investor discomfort with the health of the debt markets.
“The HPS Corporate Lending Fund, a business-development company that doesn’t trade on an exchange, said Friday it would stick to its plan to buy back up to 5% of the fund’s shares, the minimum amount it agreed to in a given quarter.
“The decision mattered this quarter because the fund, known by its ticker, Hlend, had received requests to redeem 9.3% of its shares, according to a letter BlackRock—which is helmed by Chief Executive Larry Fink—sent to investors on Friday. In the fund’s four-year history, it was the first quarter in which withdrawal requests exceeded 5%.” WSJ - Private Credit
We feel like Didi and Gogo waiting for the private credit troubles to bleed into the public markets in the form of wider credit spreads.
Money Market Flows (millions of dollars)
Money market fund flows were largely higher week-over-week. A retail flight to safety perhaps.
Mutual Fund Flows (millions of dollars)
Mutual fund flows were mixed last week.
ETF Fund Flows (millions of dollars)
Net ETF flows were positive, up in all categories.
This is another big municipal new issuance week with more than $12 billion in tax-exempt calendar issuance.
In volatile times like these, we like to remember the opening from Rudyard Kipling’s poem “If—”:
“If you can keep your head when all about you are losing theirs…”
This highlights our current SMA strategy. Our strategic targets are unchanged from the period before the Iran incursion began:
We realize that this mantra starts to sound like a broken record, but the value arguments we have spoken about before still hold. Current real yield analysis shows both Treasury and municipal securities are fair across the board (these will be updated this week with new inflation releases), the yield curve is flat, and the best values per unit of risk can be found in shorter maturities. Both five-year Treasury and municipal bonds provide investors 84–90% of the yield of similar ten-year securities with only approximately 50% of the duration risk. The long-term average for these measures is 77% for Treasurys and 68% for municipals.
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