The Time Has Come

WEEK ENDING 8/23/2024

• Powell: “The time has come” for a rate cut.
• Dis-inversion of the municipal curve.
• Money market funds still seeing cash inflows.

A CITY DIFFERENT TAKE

In his Jackson Hole speech last Friday, Federal Reserve Chair Jerome Powell indicated that the time has come for policy to adjust or, in other words, for the Fed to start cutting rates at its next meeting in September. The Fed is shifting its focus from inflation to the job market. Chair Powell commented, “We do not seek or welcome further cooling in labor market conditions.”

Now, the next question is how significant will the rate-cut cycle be? Philadelphia Fed President Pat Harker said that rate cuts should be methodical, and a neutral rate is closer to 3%. We have mentioned that a methodical rate-cut cycle is the best for the economy. You want a Fed that takes the escalator down, not the elevator.

A significant weakening of the labor market would see a big rate cut by the Fed. Data that is weaker than expected will trigger the Fed for a big cycle. The September meeting is still three weeks away, and in the interim, we see a PCE release, jobs data, and another CPI release.

We think that every meeting from now on will be a live meeting, the outcome of which will be determined by the macroeconomic data and the direction of the economy.

Last week was a big week for municipal bond investors. We saw the municipal bond curve dis-invert. The municipal bond curve is finally sloping upwards. The Treasury curve, however, is still inverted by -0.11%.

CHANGES IN RATES

Treasury yields were lower during the week. The two-year and 10-year Treasury spread ended the week of August 23 at -0.11% (same as the previous week).

This week, the story is the dis-inversion of the municipal curve. Yields in the one-year to nine-year part of the curve lowered while yields in the 10-year to 30-year part rallied. Two-year ended the week at 2.47%,10-year ended at 2.67%, and 30-year ended at 3.59%.

Municipals as measured as a ratio versus their Treasury were tighter in the shorter part of the curve and a bit cheaper in the 10-year and 30-year part of the curve.

Corporate yields were slightly lower over the week.

THIS WEEK IN WASHINGTON

The Democratic National Convention wrapped up last week with a forceful speech from Kamala Harris. As far as ratings go, the DNC slightly edged out the RNC, but the viewership was down big from election cycles past.

Geopolitical instability continues from last week with Russian missile and drone attacks on Ukraine. The latest from Israel shows a possibility of de-escalation after heavy fire between Hezbollah and Israel on Sunday.

As the election cycle heats up, China sees the U.S. messaging as restrictive of Chinese exports, calling it an act of unilateral sanctions.

Meanwhile, Vice President Harris is securing her war chest thanks to tech donors in California. Third-party candidate Robert F. Kennedy Jr. suspended his presidential campaign to endorse former President Trump. It was a move that Republicans likely welcomed but didn’t go over as well with his innermost circle.

WHAT, ME WORRY ABOUT INFLATION?

The 5-year breakeven inflation rate finished the week of August 23 at 2.25%, one basis point higher than the close of August 9. The 10-year breakeven inflation rate finished the week at 2.13%, three basis points higher than the close of August 2.

MUNICIPAL CREDIT

As of August 23, 10-year quality spreads (AAA vs. BBB) were 0.92%, five basis points lower than the August 16 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 0.60%, two basis points wider than last week. High-yield quality spreads were three basis points lower at 3.05%.

WHERE ARE FIXED-INCOME INVESTORS PUTTING THEIR CASH?

Money Market Flows (millions of dollars)

Money market funds have grown by more than $100 billion in August. The elevated rates continue to attract money into funds. This is interesting, especially given the backdrop of a high probability of a September rate cut.

Mutual Fund Flows (millions of dollars)

Bond fund categories cash flows were positive for all funds.

ETF Fund Flows (millions of dollars)

ETF asset classes experienced increased cash flows overall.

SUPPLY OF NEW ISSUE MUNICIPAL BONDS

The supply of new issues is expected to be about $9.1 billion this week.

CONCLUSION

Friday’s Jackson Hole speech by Chair Powell dominated last week’s sentiment. The directionality of a rate-cycle cut has been set by the Fed. Now, the new question is how big of a cut we will see. The big news in the municipal market this week was the dis-inversion of the municipal curve. The two-year and 10-year part of the Treasury curve remains inverted. Money market funds still see money coming in despite the market heading into a rate-cut cycle.

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