“Welcome back my friends to the show that never ends
We're so glad you could attend,
come inside, come inside”
—Emerson, Lake & Palmer, “Karn Evil 9”
It’s the Fed et al. show! On the day after the general election, the Federal Reserve Board will meet to determine the next rounds of cuts (or not). Who won the election will possibly still be up in the air, as will the future state of the Fed’s independence.
The economy looks strong. The earlier reports of its slowing were exaggerated. The employment numbers bounced back from a lackluster summer, except for the October jobs numbers (strikes and storms played havoc with the reporting). October nonfarm payrolls showed only 12,000 jobs created (expectations were for 100,000 new jobs). The source of this data is the U.S. Bureau of Labor Statistics (BLS) survey, which accounts for employment losses due to strikes and storm damage:
“The government did not estimate how many jobs were likely removed temporarily from payrolls last month. But economists have said they think the storms and strikes caused up to 100,000 jobs to be dropped. Reflecting the impact of the strikes, factories shed 46,000 positions in October.”
The unemployment rate stayed steady at 4.1%. This data comes from the household survey which does not account for strikes and storms. If a household had a job before a strike or storm it is considered employed even if temporarily not working. The Job Openings and Labor Turnover Survey (JOLTS) came in earlier in the week. At 7,443,000 the number of openings was below expectations of 8,000,000 and last month’s revised 7,861,000 — but still well above the 20-year average of 5,664,000.
Inflation has stalled. September Core PCE (Personnel Consumption and Expenditure Index less food and energy components) is the Fed’s favorite inflation measure because economists do not eat or drive. (Please excuse the old joke.) The year-over-year number was 2.7%, above expectations of 2.6% and in line with last month’s reading. But overall economic conditions look strong. The following chart of the Bloomberg U.S. Financial Conditions Index shows that the measure has declined recently but is well above the long-term average of +0.09.
The Fed’s last decision to cut the Fed Funds target range by -0.50% looks a tad aggressive in hindsight, and many pundits are questioning what the Fed will do on November 6. Prior to the September cut, the Real Fed Fund rate (adjusting for inflation) looked very, very restrictive. The 20-year average real Fed Funds rate is -0.37%. On November 1, the real Fed Funds estimate was 2.13% or 1.4 standard deviations above the 20-year average. The real Fed Funds rate was 1.75 standard deviations above the long-term average in July of 2024. Please excuse all the math and think of it this way: the last Fed move took the real Fed Funds rate from very, very restrictive to very restrictive. The FED policy goal is to find R* — ”the short-term interest rate that would prevail when the economy is at full employment and stable inflation.” The concept is a tough one because it can only be estimated by looking in the rear-view mirror. It is much like Supreme Court Justice Potter Stewart’s view of pornography: “I know it when I see it.”
The economy was not as sensitive to increases in short-term rates as in past economic cycles. What makes one think it will be sensitive to decreasing short-term rates? Since the Fed’s last move on September 19, rates have moved higher, the 10-year Treasury security has moved from 3.73% to 4.37%, and the yield on the two-year Treasury security has increased in yield from 3.59% to 4.11%. The slope of the 2-10-year Treasury securities was +.14% on September 19 and +0.16% at the end of business on November 1.
“Come and see the show.”
CHANGES IN RATES
The yield rally continues. Treasury yields moved significantly higher last week, and inflation expectations seem to be on the rise. The slope of the yield curve is positive after a two-year inversion. Concern about the deficit and both candidates' economic policies call for widening the federal deficit.
Municipal rates moved higher but not by the same magnitude as Treasury rates. The municipal market seems to be anticipating a lessening of the new issue supply onslaught.
Municipals, as measured as a ratio versus their Treasury equivalent maturities, lagged the advances of the Treasury market.
Corporate yields were significantly higher week over week.
The presidential election is finally upon us. We have battled with how to write this section. We do not possess the skills to properly compare and contrast the two candidates without offending someone (or possibly everyone). So, here are some observations of factors that are important to us:
“Our nation is a nation of immigrants. More than any other country, our strength comes from our own immigrant heritage and our capacity to welcome those from other lands. No free and prosperous nation can by itself accommodate all those who seek a better life or flee persecution. We must share this responsibility with other countries.”
A bipartisan solution on immigration was at hand but, for some reason, failed. Such failure is unacceptable. Some of the brightest people we have ever worked with are naturalized American citizens. We cannot close our doors. Lin-Manuel Miranda was right. “Immigrants, we get the job done!”
“Both presidential candidates have put forth policies that would widen the federal budget deficit during a time of robust economic growth and relatively low unemployment. That could stoke inflation and lead to higher bond yields. Harris’s proposals include more offsets to spending than Trump’s. The nonpartisan Committee for a Responsible Federal Budget estimates that Harris’s proposals would most likely increase the national debt by nearly $4 trillion over the next decade while Trump’s plans would add $7.8 trillion.” -Barron’s
“During a speech in the battleground state of North Carolina, Harris said that “building up the middle class will be a defining goal of my presidency” as she promoted her plan for a federal ban on price gouging by food producers and grocers.”
As Election Day nears, we urge you to vote. If you don’t, you have no right to complain.
The 5-year Breakeven Inflation Rate finished the week of November 1 at 2.37%, 5 basis points higher than the close of October 25. The 10-year Breakeven Inflation Rate finished the week at 2.33%, 4 basis points higher than the close a week prior.
As of November 1, 10-year quality spreads (AAA vs. BBB) were 0.98%, 3 basis points tighter than the October 25 reading (based on our calculations). The long-term average is 1.70%.
Quality spreads in the taxable market are not attractive. They ended the week at 0.79%, 1 basis point lower than the week prior. High-yield quality spreads were 3 basis points lower at 2.77%.
Money Market Flows (millions of dollars)
Overall, money market funds saw a drop in inflows compared to the week prior.
Mutual Fund Flows (millions of dollars)
Cash flows into bond funds were mixed on the week. Significant among these were outflow in municipals.
ETF Fund Flows (millions of dollars)
ETF asset classes experienced a significant drop in flows.
The supply of new issues is expected to be about $3.0 billion this week. Supply has slowed down as the election looms. This should be supportive of relative municipal bond returns.
The fixed income markets are focused on the presidential election and the potential volatility around determining the ultimate winner. The data released last week points to a solid economy. The Federal Reserve begins its November meeting on Wednesday, November 6. Our total return investment philosophy within the context of an actively managed ladder portfolio construction does not lend itself to making big bets on idiosyncratic events (elections or otherwise). As such, we are fully invested, and our durations are in the neutral range. We cannot pick a winner, so we are prepared for the worst and hope for the best.
IMPORTANT DISCLOSURES
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