Strong growth numbers released last Friday showed an impressive gain of 275,000 jobs last month. However, there were downward revisions to prior months due to seasonal weather effects dampening the impact of the strength of the February employment report.
After revision of these numbers, the average hourly earnings and hours worked continue to moderate. The unemployment rate increased by 0.2% and now stands at 3.9%. This is the highest it has been in the last two years. The Federal Reserve is watching the labor market closely. The easing of tight labor conditions in the form of a tick-up in unemployment and a slowdown in wage inflation is a positive move toward a rate cut this summer.
March completes the one-year anniversary of Silicon Valley Bank’s failure. Now lawmakers, regulators, and the market are focusing on risks in commercial real estate loans. The Federal Reserve Vice Chair for Supervision, Michael Barr, is leading the efforts to improve supervision on stress tests and identify risks in commercial real estate after the three regional banks fell last year. For now, the risk surrounding New York Community Bank Corp is labeled as idiosyncratic and not systemic.
Treasury rates moved significantly throughout all tenors in the curve.
Several of our clients have seen that the municipal / Treasury relationship has moved past the breakeven rate of 63% (1-max Federal tax rate of 37%) and have posed the question: What will bring this relationship back in line?
The easy answer is higher tax rates. However, barring that, the factors contributing to a realignment are as follows.
Investors follow up this question by asking where this realignment will come from—the Treasury side of the equation or the municipal side. By our way of thinking, it doesn’t matter; we all live in a relative world and make relative total return decisions.
One other thing of note. AAA general obligation municipal bonds should trade at a premium to Treasury securities, especially for maturities longer than ten years. The reasons are as follows:
We believe that the relative value relationship between Treasury securities and municipal securities, all else equal, will revert to a more normal distribution in the next few months as the supply of new issue municipal bonds increases and the market approaches April 15. Tax season is a theme for another piece.
The municipal market moved lower across the entire curve.
The municipal/Treasury ratio proceeded to get more expensive in the 1-10 year part of the curve. Ratios are rich relative to Treasury but also to US corporates.
Rates in the corporate market segment came down in a significant way.
President Biden came off assertive in his State of the Union address. Some view the State of the Union as the start of his campaign for the November elections. The audience was heavily politicized, with attendees draped in Ukraine colors and Trump merchandise.
Biden’s framework for re-election was laid in raising taxes for the wealthy and expanding a cap on insulin prices and drug costs. President Biden will use the budget proposal for fiscal 2025 to double down on tax hikes for wealthy Americans and large corporations. There were also promises to re-enact Roe V. Wade and to expand background checks on gun purchases.
A House committee has put forth a bill that could be the start of a ban against TikTok. This ban prevents TikTok from being available on US app stores, which is currently being used by 170 million Americans. The irony here is that President Biden launched his re-election campaign on TikTok but has agreed to go ahead with the ban if the bill is presented to him.
On the geopolitical front, the President is warning Israel against the invasion of Rafah, which would be a “red line.” He was hoping to have a breakthrough in the conflict before the start of the holy month of Ramadan, which started Sunday.
The 5-year Breakeven Inflation Rate finished the week of March 8 at 2.34%, six basis points lower than the March 1 close of 2.40%. The 10-year rate finished the week at 2.28%, four basis points lower than the close of March 1 at 2.32%.
10-year quality spreads (AAA vs. BBB) as of March 8 were 1.19%, four basis points tighter than the March 1 reading of 1.23% (based on our calculations). The long-term average is 1.71%.
At 0.70%, quality spreads in the taxable market last week were seven basis points tighter than the week before. High-yield quality spreads on March 8 were at 2.93% versus 3.01% last week.
Much like the municipal market supply, the credit market supply is heavier in March compared to the first two months of the year. We have seen $389 billion in new supply YTD. This is 31% higher than the same period last year. However, last year the macro environment was a lot more uncertain. The higher issuance also shows the issuer mindset that is no longer expecting much lower yields or a recession.
Money Market Flows (millions of dollars)
Money market funds saw positive flows in both tax exempt and government category while prime saw outflows.
Mutual Fund Flows (millions of dollars)
Bond funds saw a large inflow into the investment grade and total taxable market share, while Municipal and high-yield mutual funds saw a net drop in flows.
ETF Fund Flows (millions of dollars)
ETFs saw a drop in weekly issuance. However, municipals had a small uptick in issuance.
This week boasts of an exciting tax-exempt calendar at close to $10 billion. We will be watching the market closely to see if spreads that are razor-tight give in as the market absorbs the supply.
The employment data last week was messy because of seasonal revisions. However, unemployment did tick up while wage inflation ticked down. We have attempted to answer the question of muni-treasury ratios being on the rich side of fair and whether we will see a revision to the long-term averages. President Biden has kicked off his campaign using the State of the Union address as a platform.
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