(New York)
Those worried about rate hikes will be happy to hear this news. Ever-hawkish Jerome Powell is finally starting to sound just a bit more dovish. Powell says the economy is strong, but could face “headwinds”. He says the Fed is discussing how much and how fast to raise rates and acknowledged that the Fed’s actions could inhibit the economy. He said the Fed’s goal is to “extend the recovery, expansion, and to keep unemployment low, to keep inflation low”.
FINSUM: It is good to hear some public consideration that rates might get in the way of the economy. While we would not exactly say this is dovish, it is certainly less aggressive than previously.
(New York)
With all the volatility of the last month, and midterms, less focus has been on one of the most ominous of economic signs—the yield curve. Well, Goldman Sachs has just weighed in, warning investors that a yield curve inversion is looming. Goldman went further than to say that 2-years might be flat or overtake 10-years, the bank said that spreads between 2- and 30-year bonds would fall to zero. To put that call into perspective, it would be a narrowing of 50 basis points versus now. Goldman highlighted the move in its top themes to watch for 2019.
FINSUM: We have to give Goldman Sachs a little credit here as they have been consistently hawkish about rates for at least a year and are sticking to it. We tend to agree with this view.
(New York)
One of the safe bets during bouts of volatility since the Financial Crisis has been to pile into Treasury bonds anytime things got tough. Every time stocks dipped, the bonds tended to rally strongly and became a safe haven. However, since the recent downturn in equities, this correlation has ceased. Even amidst stock and oil’s plunges recently, Treasuries have basically remained flat, giving no comfort to investors.
FINSUM: The big difference this time around is that the volatility is coming during a period of rising rates, which means Treasury bonds are not as safe a bet as in the past several years.
(New York)
Everyone is watching the BBB bond market with a very close eye. The bottom fringe of the investment grade market, it saw an extraordinary jump in issuance over the last few years. Now, with rates rising, it looks very vulnerable. However, all that suspicion hasn’t amounted to much as investors have kept the area afloat. Ratings agencies and the IMF have both warned about the startling growth of BBB issuance, but so far, the sector is holding up.
FINSUM: Don’t be fooled. There is a massive amount of BBB debt and when a recession finally arrives alongside much higher rates, there seems bound to be a reckoning. That said, there are pockets of the market, like utilities credits, that seem like they will hold up better.
(New York)
There are a lot of investors out there worried about rates moving higher and bond prices falling as a result. Treasury yields have moved much higher over the last year, which has spooked investors. All that said, one fund manager thinks investors shouldn’t fret too much. The reason why is that markets likely have already priced in rate hikes in, so losses shouldn’t be much. Furthermore, we have actually entered a more normal yield environment, where one can earn meaningful yields on shorter-term credits that don’t have much interest rate risk.
FINSUM: This article raises a good point about the current yield environment. While rate driven losses are worrying, we have finally entered an environment where one can earn comfortable yields on interest rate hedged portfolios.
(New York)
Here is something no one was calling for before the election—the yield curve has has flattened considerably since the midterm results. The spread between two- and ten-year Treasuries got as low as 25 basis points. The market thinks the US deficit may be tighter than in an all-Republican scenario, which has sparked a rally in ten-years.
FINSUM: A flattening yield curve on its own does not necessarily indicate recession, but if it does invert, look out, as that is one of the most reliable indicators of a looming slowdown.
(New York)
Almost all of the market articles regarding the results of the midterms have been about stocks, including which sectors might thrive etc. But the real winner might be the bond market. Treasury yields have fallen and spreads between short and longer term bonds have tightened. The reason why is that traders see the forthcoming US budget as more conservative now that Congress is split. In particular, the market thinks there won’t be a big surge in infrastructure spending, and Treasury bond issuance will probably be tighter, both of which have conspired to boost prices.
FINSUM: It is quite odd to think that the election of a Democrat majority to the House would make the market expect more conservative fiscal policy, but the reality is that a divided Congress will probably be less fiscally loose because of gridlock.
(Washington)
Investors can breathe a sigh of relief, but only for a moment, as it looks unlikely that the Fed will hike again in its next meeting this week. The Fed will not be releasing updated projections after this meeting. That said, improvements in the labor market recently make it likely that the central bank will hike rates at its meeting next month. The Fed is supposed to discuss this week all the things you might expect: “the economy, financial markets, and the future path of rates”, according to the WSJ. Fed chairman Powell will not be holding a press conference after the meeting.
FINSUM: This Fed is so hawkish and the economy is rolling so well that even a month’s break from hikes seems like a reprieve. We are a long way from 2013.
(Washington)
This midterm election might have ended up being very consequential for muni bond markets. Some in the muni market feared the possibility of the Republicans maintaining control of both the House and Senate because of how further tax changes could have hurt the finances of municipalities. However, now that Congress is split, the outlook seems more favorable. The reason why is that Congress now looks more likely to restore a tax exemption for a debt refinancing strategy that is often used by local governments.
FINSUM: Just like in other asset classes, having a split Congress looks favorable for munis.
(New York)
There is some alarming data flowing out of the bond market. First it was the huge amounts of bond fund withdrawals, and now new info—issuance is plunging. US investment grade issuance fell 34% in October (from September). High yield issuance was down 50% from last October. Overall annual issuance fell a great deal on both fronts as well. The numbers reflect slumping demand for bonds as rates and yields rise. Investors also pulled $3.1 bn from investment grade bond funds in the week leading up to November 1st.
FINSUM: This is not surprising given what has been going on in markets this month. Even the annual figures make sense given the rise in rates. The big worry is to what degree this will translate into lower demand for Treasuries at the same time as the deficit (and issuance) is about to surge?
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(Washington)
Here is an eye-opener for investors: one of the biggest market reactions to the midterms is likely to be in munis. In particular, yields on munis are expected to fall is the Democrats take the House, which would result in a split Congress. The reason why is that such an outcome would likely limit the further possible damage that could be wrought by Republican tax proposals. However, since the market is anticipating this outcome, if Republicans do maintain their hold on the House and Senate, then yields could rise sharply. The call on the moves comes from Barclays.
FINSUM: The most likely outcome right now seems to be a blue House and a Red Senate, which would mean smooth sailing and likely gains for munis.
(New York)
One of the big worries in the Treasury market is that foreign demand is waning for Treasury bonds at the same time as supply is surging. This is leading many to stress that US government bond prices could be in for a big fall. However, Bloomberg says that won’t happen. The logic just isn’t there, and neither is the data to back it. Inflation and rates are rising, and so is the Dollar, making the bonds more attractive to hold. Further, US yields and credit-worthiness are looking increasingly positive given the bond market turmoil in Europe.
FINSUM: Because the Dollar is still the dominant world currency, there is a lot of built-in demand for Treasuries. And given the state of US yields versus the rest of the developed world, we don’t think foreign demand is going to shrink.
(New York)
Inflation has been ticking higher, but it has not been high enough to cause real concerns. Despite this, the Fed has still been very hawkish, hiking rates several times. Well, that mild inflation may be about to change. Anecdotal evidence of corporate behavior shows that companies are increasingly passing along costs to consumers. In everything from soda to bleach to cookies, companies have been raising prices. Explaining the moves, the CEO of Mondelez says “The consumer environment is strong”. Prices across the supply chain have been rising, helping to drive higher pricing.
FINSUM: Consumer sentiment and spending is strong and this seems like the ideal environment in which to raise prices. Thus we think headline inflation is going to start to rise.
(New York)
Investors need to face reality (not that they aren’t), this Fed is more hawkish than any since the Crisis, and despite the market turmoil there will be yet another hike before the end of the year. Rates will keep rising so long as the economy stays strong. That means investors need to prepare. They have mostly done so by fleeing bond funds, but that may not be wise, as there are some very attractive funds that can help offset interest rate risk. For instance, check out the ProShares Investment Grade—Intr Rt Hdgd (IGHG) and the iShares Interest Rate Hedged Corp Bd ETF (LQDH). IGHG is particularly interesting because while both funds go long corporate bonds and short treasuries to produce zero duration, IGHG holds less BBB rated bonds and has a higher quality portfolio, all of which has let the fund appreciate this year even as rates rose strongly.
FINSUM: There are some very solid and creative bond funds out there to help offset rate risk while still earning decent yields. Given where equities are right now, these seem like good buys.