Debates

WEEK ENDING 7/5/2024

• When will the Fed make its next move?
• Costs of avoiding the “Cash Trap” are on the rise.
• Try not to laugh: “His Highness, the President of the United States of America and Protector of their Liberties.”

A CITY DIFFERENT TAKE

It has been an eventful two weeks. But to be truthful, most of the action came after Thursday’s presidential debate; more on that later.

The 10-year Treasury note closed Thursday, June 27, at 4.29%; on Friday, June 28, it closed at 4.40%, a 0.11% move based on debate results (most likely). As of this writing, the yield on the 10-year Treasury note is 4.31%.

Back in the real economy, job openings increased to 8,140,000, up from a downward revision of 7,919,000 in April. This exceeded expectations of 7,946,000. On Tuesday, Chair Powell was reported by our favorite Fed whisperer Nick Timiraos to have said,

“(Powell) was pleased with how inflation had resumed a downtrend following a rebound at the start of the year, a sign the central bank might be able to lower interest rates by the end of the summer even though he declined to endorse such a move.”

Friday’s jobs numbers came in at 206,000, beating expectations of 190,000. Last month’s number of 272,000 was revised downward to 219,000. The unemployment rate increased to 4.1% from 4.0%; expectations were for 4.0%. Average hourly earnings Y/Y were 3.9%, matching expectations and down from last month's 4.1%.

The Fed easing sweepstakes is back in full gear. It must be a slow holiday news cycle, because expectations of the next Fed easing are all the talking heads can talk about. The following table shows the market’s implied Fed easing probabilities by meeting from December 2023; you be the judge if it is worth the airtime and oxygen.

This table resembles a numerical representation of Samuel Beckett’s “Waiting for Godot.” The market is pretty certain that the next Fed move will be a cut, but the big question is when. Bond and equity markets are hanging on the answer. Next week's inflation numbers loom large for the market’s expectations of the next Fed action.

Avoiding the “Cash Trap” is getting more expensive.

We have talked about avoiding the “cash trap” for some time. The cash trap occurs when investors pour money into money market funds (currently yielding more than 5.00%), expecting that income to be durable. The average maturity of many money market funds is around 30+ days. If the Fed does ease, those yields will decrease quickly. One low-risk way of insuring oneself against this eventuality is to combine money market allocations with a slightly longer investment vehicle. This would give the investor a more durable dividend with a slightly longer duration (1–2 years). This insurance has gotten more expensive as of July 5. Based on monthly yield quotes for a 3-month Treasury bill (a proxy for a money market fund) and a 2-year Treasury note (a proxy for a slightly longer investment vehicle). The average yield spread from October 31 through June 28 was -0.30% (the yield of the 2-year Treasury notes was 0.30% less than the yield of the 3-month Treasury bill). As of Friday’s close, that spread is -0.62%, double the 1-year average. More expensive but still worth it in our estimation.

CHANGES IN RATES

Treasury yields were mixed over the last two weeks, point to point. The Treasury curve steepened over that period +0.13% as measured by the 2–10 spread (-0.45 on June 21 versus -0.32 on July 5).

Municipal yields were marginally higher over the two-week period.

Most municipal maturities cheapened versus their Treasury equivalents. Most except very long-dated maturities.

Corporate yields were mixed over the two-week period.

THIS WEEK IN WASHINGTON

Who won? There were no winners; the American people lost.

One choice is the current president, whose competency is in question based on last Thursday’s debate. “Babbling and hoarse: Biden’s debate performance sends Democrats into a Panic” The New York Times called for President Biden to step down. They were joined by several Democratic lawmakers. Is it time to take away the keys? Anyone who has had to ask for the car keys from a parent knows how gut-wrenching these conversations are.

The other choice is a convicted felon, to which the truth seems to be a foreign language he has not mastered. We will let Steve Rattner handle the facts on three of former President Trump’s hallucinations: bounce-back jobs, the largest tax cuts in history, and immigrant crime. You all can be the judge for yourselves.

Elsewhere in DC:

 SCOTUS granted immunity for official acts of former presidents,

“The court’s conservative majority said former presidents have absolute immunity from prosecution for official acts that fall within their ‘exclusive sphere of constitutional authority’ and are presumptively entitled to immunity for all official acts. They do not enjoy immunity for unofficial, or private, actions.”

 The definition of “Official Acts” has not been resolved. Not surprisingly, the three liberal justices dissented.

“The three liberal justices — Sonia Sotomayor, Elena Kagan and Ketanji Brown Jackson — sharply criticized the majority’s opinion in scathing dissents. Sotomayor gave a dramatic speech as she read her dissent from the bench, at times shaking her head and gritting her teeth as she said the conservative majority wrongly insulated the U.S. president as ‘a king above the law.’”

If SCOTUS has anointed a “king,” maybe we should change how we refer to the president. John Adams had some ideas: 

1. “His Elective Majesty” — one can only guess how long the “elective” part will be needed.
2. “His Mightiness” — most bullies would like this one.
3. “His Highness, the President of the United States of America and Protector of their Liberties”— this one should get the biggest laugh.

 With snap elections in France and Britain’s revolving door of prime ministers, it seems that our key allies are also experiencing similar turmoil. Hold on folks, the ride is getting even bumpier!

WHAT, ME WORRY ABOUT INFLATION?

The 5-year Breakeven Inflation Rate finished the week of July 7 at 2.34%, which was higher by seven basis points from the close of June 21. The 10-year Breakeven Inflation Rate also finished the week at 2.28%, five basis points higher than the close of June 21.

MUNICIPAL CREDIT

10-year quality spreads (AAA vs. BBB) were 1.06% as of July 5, wider by 14 basis points from the June 21 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 unchanged at 0.70%, while high-yield quality spreads were higher at 3.01%.

WHERE ARE FIXED-INCOME INVESTORS PUTTING THEIR CASH?

Money Market Flows (millions of dollars)

Money market funds saw increased cash flow over the last two-week period. The cost of “Cash Trap” insurance is getting richer.

Mutual Fund Flows (millions of dollars)

Bond fund categories saw mixed cash flows.

ETF Fund Flows (millions of dollars)

ETF asset classes experienced positive cash flows overall, with municipal ETFs seeing net outflows.

SUPPLY OF NEW ISSUE MUNICIPAL BONDS

The supply of new issues is expected to be about $9.1 billion this week, continuing the heavy tax-exempt supply.

CONCLUSION

To borrow a phrase from Samuel L. Jackson in the movie “Jurassic Park,” — hold on to your butts. It is going to be a rocky election season and, by extension, a volatile fixed-income market. Will politics outweigh market realities? Will one candidate's ideas on tariffs drive increased inflation expectations? (Ever heard of Smoot/Hawley?) Will confidence in the other’s competence demand a higher risk premium for U.S. Treasuries (not to mention the increased supply on the horizon)? Will the Fed disappoint and not ease as the market thinks it will? And if it does ease, what does that mean for the economy and the stock market? What is the next rabbit to pop out of SCOTUS’s hat? We will have to wait until October for this one.

All of this sounds quite alarming. However, looking back at history, we can take solace in the fact that the republic has survived other periods of discord. From an investment standpoint, volatility brings opportunity. Within the fixed-income framework, we feel the best way to take advantage of volatility (not surprisingly) is through an actively managed, total return-focused, laddered portfolio. Our fixed-income strategies are positioned in their neutral duration range with an overweight to the shorter end of their respective investment universes. We will be investing alongside our clients in such vehicles.

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