With the Federal Reserve’s meeting behind us, recent data releases are confirming their analysis of the hard and soft data. The one thing we can say for certain is that volatility is on the rise. Bonds are reacting to the day-to-day moves in the stock markets, more than the fundamental underlying economic data. (Yet another reason for a long-term diversified portfolio of stocks and bonds versus day-to-day overreactions.) The yield curve has steepened.
The Hard Data
“The ‘hard’ data — which shows low unemployment, healthy levels of job creation, slowing but still-solid consumer spending — suggests the U.S. economy is ‘healthy,’” Powell said. The Hard Data
The employment data to date looks healthy (we will know more next week), but it is difficult to tell if the effects of the federal government’s work force reductions are captured in that data. Also, many of the federal firings are still caught up in the courts.
We are concerned about one piece of employment data that could be a precursor to tougher economic times and slower growth. Job openings per unemployed worker is 0.9 as of Jan. 31 (the most recent data available), well below the 15-year average of 1.86. Challenger Gray & Christmas, Inc.’s February job cuts report shows a troubling increase in layoffs: U.S.-based employers announced 172,017 job cuts in February, the highest total for the month since 2009, when 186,350 job cuts were recorded.
Forecasts of economic growth as measured by GDP are all over the place. The Atlanta Fed’s GDPNOW forecast started the year at +2.586% on Jan. 2 and came in on March 28 at -2.804%. Inflation is proving sticky as many pundits have warned. Year-over-year core PCE (the Fed’s favorite inflation measure) was released Friday at 2.8%, well above the 20-year average of 2.03% (which is surprisingly close to the Fed’s target of 2.0%). The prior month’s release was revised up to 2.7% from 2.6%.
The Soft Data
“But that ‘soft’ data isn’t necessarily indicative of economic weakness,” Powell said Wednesday. “That probably has to do with turmoil at the beginning of the administration.” The Soft Data
The best way to look at University of Michigan Consumer Sentiment Index and the Conference Board Consumer Confidence Index soft data is graphically:
This measure has shown significant declines recently into territory that we would term “concerning.”
The decline in Consumer Confidence is not as dramatic as the decline in Consumer Sentiment, but both measures show significant declines.
The market volatility associated with federal workforce reductions and trade war worries (not to mention stock market volatility) is impacting the consumer. The $64,000 question is, “Do these worries affect consumer behavior?” If they do, this could lead to slower growth against a backdrop of sticky inflation that should increase with a trade war.
What does this all mean? Chaos in Washington makes our crystal ball cloudy. Some predictions of a growth downturn over the next 12 months have increased to about 43%:
The probability of a downturn in growth over the next 12 months is about 43%, as set by the average view of 400 respondents during the period of March 17–20. Probability of a Slowdown Increases
We do think that the outcome is not just a choice between slowdown or continued growth. We think the risk of stagflation is increasing!
CHANGES IN RATES
Week-over-week changes in Treasury yields were muted. This week, the yield curve steepened to +0.38% from +0.31% last week.
Interest rates in the municipal market moved higher on the week, no doubt anticipating an increase in new issue supply.
Relative yield ratios reflect the difference in yield changes for the two fixed-income markets. Ratios were generally up last week in anticipation of an increase in new issue supply.
Corporate yields were also higher week-over-week.
The Washington chaos continues.
April 1 is April Fools’ Day, immediately followed by “April Tariffs’ Day” on April 2. (Or “Liberation Day”, if you prefer.) Future tariff policies will be announced, but that could change on a daily basis. It’s anybody’s guess what that will bring, but market volatility is guaranteed. 25% tariffs were announced on foreign autos and auto parts (impacting about 7 million cars imported into the U.S.), causing the big three U.S. car manufacturers’ stock to take a “kick in the shin.”
The latest story capturing headlines has to do with group chat.
“The Atlantic publishes full Signal chat messages showing military plans about U.S. strikes in Yemen.” Oops
With all this finger-pointing, a politician’s going to get an eye poked out.
The president pulled his nominee for U.S. ambassador to the United Nations this week:
“Trump withdraws Rep. Elise Stefanik’s nomination for U.N. ambassador, citing tight GOP House margin.” A Public Opinion Shift
Democrats have won a few upset victories in Republican strongholds. The administration’s policies could be shifting some public opinion. We think it is still too early to draw conclusions, but the U.N. move does seem to highlight an increasing concern.
The 5-year Breakeven Inflation Rate finished the week of March 28 at 2.16%, 1 basis point higher than March 21. The 10-year breakeven inflation rate finished the week at 2.37%, which is 4 basis points higher week-over-week.
As of March 28, the 10-year quality spreads (AAA vs. BBB) were 0.99%, up 8 basis points from the prior week (based on our calculations). The long-term average is 1.69%.
Quality spreads in the taxable market are not attractive. They ended the week at 0.98%, 4 basis points lower than the prior week. High-yield quality spreads were wider by 21 basis points at 3.29% week-over-week.
Money Market Flows (millions of dollars)
Overall, money market funds saw increased flows.
Mutual Fund Flows (millions of dollars)
Cash flows into bond funds were negative week-over-week across most categories except municipal, which was also down from the week prior.
ETF Fund Flows (millions of dollars)
ETF asset classes experienced much lower net flows for the week, driven by the taxable category.
The supply of new issues is expected to be closer to $9.1 billion this week.
The fixed income markets seem to be shrouded in chaos and volatility. Stock market moves, tariff announcements, DOGE announcements, and court rulings are the main drivers of daily fixed income variability. We choose to focus on underlying economic fundamentals (be they soft or hard) and our commitment to investing for the long term. As such, our strategic outlook is to remain neutral with regard to duration positioning, overweighted to the short end of our SMA investment universes, and focused on higher credit quality. We think all this chaos will lead to higher interest rates (without much conviction), a steeper yield curve (with strong conviction), and wider credit spreads (also with strong conviction).
It is times like these that test an investor’s commitment to long-term investing. We believe that “focus” is a winning strategy to endure these chaotic times.
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