A Santa Claus Rally?

WEEK ENDING 12/01/2023

• Chair Powell tries to calm fixed-income markets.
• 60% probability of a Q1 rate cut.
• Hostages released during last week's Israeli-Hamas cease-fire.

A CITY DIFFERENT TAKE

As we enter the holiday season, the fixed income markets are behaving as if they received their presents early — low inflation and a gentle slowdown in the economy. Chair Powell tried to do his best Scrooge impression, but the markets were not buying it.

The market's expectation of 2024 rate cuts, as measured by Bloomberg’s WIRP function, reached 60%, targeting a March timeframe. Markets do tend to get ahead of themselves. The November inflation reports have come in under expectations and show that no matter which series you look at, inflation numbers seem to have rolled over but are still considerably above the Fed’s 2% target.

Maybe with each additional friendly report, an “inflation angel” gets their wings?

CHANGES IN RATES

The rally in Treasury yields continued this week. There was a little respite on Thursday after the PCE numbers were released. Year-over-year core PCE came in at 3.5%, lower than last month’s 3.7%, but matching expectations. This number is still well above the Fed’s 2% target. The fixed-income markets are pricing in Fed rate cuts at the end of Q1 2024 with a probability of 56.2%.

The municipal market has rallied much more than the Treasury market since Thanksgiving, aided by low levels of new issuance supply and market participants suffering from a bad case of a certain kind of FOMO — fear of not being fully invested and missing the much-expected January rally.

The municipal/Treasury ratios are lower (except for the 5-year maturity). Municipal bonds have outperformed the Treasury market over the last two weeks. The municipal/ Treasury ratios indicate that Treasury securities provide a better after-tax yield than AAA general obligation municipal bonds. We will see how long this lasts.

Corporate yields moved mostly lower last week; corporates joined the party.

THIS WEEK IN WASHINGTON

Congress has one less Republican representative from New York. George Santos was expelled from the House last week for ethics violations. Because he was not convicted of anything, he retains certain privileges as a now-former member of Congress, including access to the House floor, dining room, gym, and cloakroom — but not security. Ain’t life grand? (At least in D.C.)

After a brief cessation of violence last week (allowing for the release of a handful of hostages), Israel’s war on Hamas has resumed.

It has been widely reported that Hunter Biden is willing to testify publicly on Capitol Hill, but House Republicans want testimony to be held in a private, closed session. Is that because they are concerned about what photos Rep. Marjorie Taylor Greene will bring?

WHAT, ME WORRY ABOUT INFLATION?

The 5-year Breakeven Inflation Rate finished the week at 2.32%, one basis point higher than the November 17 close of 2.31%. The 10-year Breakeven Inflation Rate finished the week at 2.22%, no change from the November 17 close.

MUNICIPAL CREDIT

10-year quality spreads (AAA vs. BBB) as of December 1 were 1.28%, seven basis points lower from the November 17 reading of 1.35% (based on our calculations). The long-term average is 1.71%.

Quality spreads in the taxable market are not attractive but were narrower last week, ending the week at 0.78%. High-yield quality spreads moved from 3.47% on November 17 to 3.40% on December 1.

WHERE ARE FIXED-INCOME INVESTORS PUTTING THEIR CASH?

Money Market Flows (millions of dollars)

Mutual Fund Flows (millions of dollars)

ETF Fund Flows (millions of dollars)

SUPPLY OF NEW ISSUE MUNICIPAL BONDS

This week’s supply estimates are slated for somewhere around $11.0 billion (there may be a lump of coal in this package).

CONCLUSION

Fixed income markets are moving, and it looks like there will likely be a Santa Claus rally. However, markets do tend to get ahead of themselves. Inflation, while rolling over, is still above the Fed’s 2% target. Chair Powell tried to do his best Scrooge impression (or was that Greenspan?) and calm this exuberance but to no avail. To paraphrase the Grateful Dead, “We may be going to hell in a bucket, babe. But at least we are enjoying the ride.”

Or maybe Francis Pharcellus Church was correct. “Yes, Virginia, there is a Santa Claus.”

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