WEEK ENDING 8/2/2024
- Welcome home, Paul Whelan, Evan Gershkovich, and Alsu Kurmasheva
- Paris took center stage…
- Until the jobs report spoiled the party, that is.
A CITY DIFFERENT TAKE
On Thursday, the Biden administration announced the largest prisoner swap since the Cold War. Three U.S. citizens held in Russian custody were exchanged for eight Russians jailed in the West, including a spy/hitman held in German custody for murder. Russia released a total of 16 prisoners. Ongoing multi-national negotiations began in 2022 and continued with no leaks from the administration. Early reports highlight the importance of alliances and personal relationships, as well as the importance of an administration composed of highly qualified individuals (i.e., no leaks). The WSJ detailed what was required to free their jailed reporter. Not bad for an old lame duck.
Here is an interesting fact: “U.S. citizens detained abroad still face tax fines.”
Chris Coons from Delaware is championing a change.
“Coons, a Democrat, said it was one of the easiest bills in his tenure to get the support of his colleagues. “Their initial response is, ‘Wait, that's true? When you are released from being a hostage and come home to the United States, the IRS fines you?’ Yes, they have to. And if we don't pass this bill, they'll keep doing it,” he said. Coons added the process has implications beyond the actual bill itself. “Frankly, doing legislation like this also helps sustain the muscle memory of what it means to legislate together,” he said.”
There is still hope that Congress can be productive, at least when all parties see votes behind their actions.
The Paris Olympics took center stage this week (until other events pushed them out of the spotlight). The U.S. women's rugby sevens team captured a bronze medal and the attention of Jason Kelce (famed cheater at arm wrestling). This is the first-ever medal for the women’s rugby team and the first medal for U.S. rugby since 1924, when the men’s 15s team won gold.
Simone Biles proved herself the “G.O.A.T.” with a sense of humor. After achieving gold medals in the women’s team final and women’s all-around, she posted, “I love my black job.”
Congratulations, ladies!
And then the “it” hit the fan.
The week was shaping up to be very pleasant prior to Friday's jobs report. After a series of Goldilocks economic releases, the jobs report came out much weaker than expected. Nonfarm payrolls increased by 114,000, falling short of expectations of 175,000. Last month's reading of 206,000 was revised down to 179,000. The unemployment rate rose to 4.3% versus an expectation of 4.1%. And those were the highlights.
The S&P 500 index lost -75.62 (1.37%) points on Thursday and followed that with an additional loss of -100.12 (1.84%) on Friday. Bonds rallied, and the ten-year Treasury bond declined in yield by 0.19% (a big one-day move). The slope of the yield curve has been steepening in the last few weeks. The spread was -0.17% at the close of business on Thursday. The spread was -0.08% as of the close of business Friday. Another measure we have focused on is the yield spread between the three-month Treasury bill and the two-year Treasury note. For much of the early part of the year, that spread stood at approximately -0.30%. Pretty cheap insurance to escape the “cash trap.” At the close of business, that spread was -1.41% (a 4.7x increase in the cost of insurance).
All of this leads to the market’s opinion that Fed rate cuts are coming. Below is a table highlighting the market’s implied probability of rate cuts for the remainder of 2024. It could be an overreaction; that has happened in the past. One data point does not make a trend, but we think the economy is slowing, and rate cuts this year are a real possibility — but the market has overreacted to this possibility all year. As always, the Fed will wait to see if the data supports such a move.
CHANGES IN RATES
Treasury yields were much lower over the week. The jobs report spurred a big rally on Friday. The anticipation of a September rate cut is growing. Evidence of this anticipation can be found in the two-year and 10-year Treasury curve. (Repeating last week’s statistics seems worthwhile.) That spread finished the week at -0.08%; one month ago (June 28), it was -0.36%. For a little context, since September 1994, the average spread has been +0.97%. The max spread was +2.89%, with a minimum spread of -1.06%. What a long way the market has come.
Municipal yields were lower last week, declining at approximately half the rate of their Treasury equivalents. The ratio table below highlights the relative differences.
Municipals, as measured as a ratio versus their Treasury equivalent maturities, were significantly higher over the week.
Corporate yields were significantly lower over the week.
THIS WEEK IN WASHINGTON
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“The Veepstakes” should conclude this week. What are the odds that Vice President Harris’s choice will give JD Vance a run for his money? Last week's prisoner exchange highlighted the importance of having quality people in the administration. Mr. Vance’s idea that voting rights should be proportional to the number of children one has is interesting but apparently not a new concept. But really, does anyone want Nick Cannon to have that much voting power? This brings to mind an early constitutional compromise that we will not mention.
Kamala Harris’s run for the White House has gotten off to a quick start; she raised around $300 million in approximately 11 days. But a weakening economy, if that is the case, could prove problematic.
WHAT, ME WORRY ABOUT INFLATION?
The 5-year breakeven inflation rate finished the week of August 8 at 2.19%, lower by 22 basis points from the close of July 26. Most of the change -0.15% occurred after the jobs report was released. The 10-year breakeven inflation rate also finished the week at 2.04%, 23 basis points lower than the close of July 26. Again, most of the decrease was on Friday (-0.16%).
MUNICIPAL CREDIT
As of August 2, 10-year quality spreads (AAA vs. BBB) were 0.94%, four basis points lower than the July 26 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 0.93%, 15 basis points higher. High-yield quality spreads were 53 basis points higher at 3.46%. This is not surprising; if the economy is weakening, profitability will be questioned, along with the ability to service debt.
WHERE ARE FIXED-INCOME INVESTORS PUTTING THEIR CASH?
Money Market Flows (millions of dollars)
Most money market funds saw lower weekly cash flows. Tax-exempt money market funds were the exception.
Mutual Fund Flows (millions of dollars)
Bond fund categories saw mostly positive cash flows, except for the Investment Grade category.
ETF Fund Flows (millions of dollars)
ETF asset classes experienced positive cash flows overall, but a large drop from the prior week.
SUPPLY OF NEW ISSUE MUNICIPAL BONDS
The supply of new issues is expected to be about $15.3 billion this week. The onslaught of heavy supply starts up again.
CONCLUSION
This week has been volatile. The recent economic data has given the Fed reason to cut short-term interest rates, but when and by how much is the $64,000 dollar question (kids, that was an old TV game show).
As events are lining up, we think the strategy of overweighting the short end of the individual Separately Managed Accounts’ investment universe will begin to pay off (more than it already has). Volatility is a force investors must learn to manage.
With so much activity on the global economic and political stages, we expect the volatility to continue. As we’ve said before and will likely say again “Buckle up!”
IMPORTANT DISCLOSURES
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