by Gayl Mileszko
Dime-a-dozen economists and campaign-mode politicians remind us on a daily basis that we are in the midst of an inflationary surge not seen in over forty years — as if we were not quite personally and acutely aware of prices that are spiking around us just about every 24 hours. It is true that from 1978 to 1981 the U.S. endured four years of increases in the Consumer Price Index that rose on a year over year basis from 6.7% to 9.0% to 12.5% and 13.3% before finally falling to 3.8% in 1982. The Federal Reserve responded by raising rates in ways we cannot presently fathom: from 6.50% to 10% to 12% and even 18%. The economy did not in fact recover until 1983 and it took another 10 years for Fed Funds rates to fall to 3%. The Dow Jones Industrial Average was just above 800 at the start of the 1970s; by the end of the decade it had only advanced to about 839, a 5 percent return that looks pretty good against the 6% loss being experienced so far in 2022.
History Worth Reviewing: the 1970’s
Not forty but fifty years ago, the U.S. suffered through nearly a decade of stagflation as a result of monetary and fiscal policies and an oil embargo. We have recently seen some unprecedented federal intervention but, back in August of 1971, President Nixon imposed the first and only peacetime wage and price controls which evolved in four phases that did not end until April of 1974. What was it like? In 1972, inflation rate was 3.4% and the Fed Funds rate was 5.75%. We had more than 156,000 troops in Vietnam and this was the year of the Munich Olympics terrorist attack and the Watergate scandal. Americans, as always, continued with their lives and celebrated entrepreneurs and champions. Sporting news was dominated by the Lakers, the Bruins, the Cowboys, the Oakland A’s and Jack Nicklaus. American Pie topped the music charts. Frederick Forsyth and Herman Wouk novels were among the best sellers. On TV, we watched All in the Family, Hawaii Five-O, and Ironside. Most everyone went to the movies to watch Marlon Brando and Al Pacino in the blockbuster film, The Godfather with its extraordinary characters — Don Corleone, Michael, Sonny, Fredo, Connie, the consigliere, Barzini, Pentangeli – with all of its brutal mob violence and unforgettable dialogue. We heard cold refrains about many actions being “not personal, strictly business” while hearing for the first time about various unfortunates “sleeping with the fishes”.
The Godfather: 50 Years Later
There is a new 50th anniversary edition of the film adaptation of Mario Puzo’s best-selling novel by Francis Ford Coppola playing in AMC Dolby Cinemas, and the series is available on Netflix. Both companies can badly use a boost in sales. Netflix just lost 200,000 global subscribers in the last three months and AMC domestic box office receipts are still 44% below where they were in 2019. Millions will be attracted to the striking imagery on the big screen and the sight of true movie stars. Since the original aired, we have somehow become more tolerant of attacks on the American Dream, but not so much anything that resembles ethnic stereotyping. We also have new villains now, new horrors, new versions of corruption and new criminal underworlds alongside astonishing technological developments and increases in wealth and profit potential.
Changes in the Past Half Century
The financial markets have become much more global and complex in the last five decades. But investors have been presented with plenty of offers they “could not refuse” for fear of missing out, ranging from hedge funds and collateralized debt obligations to index funds and exchange traded funds, to individual retirement accounts, Build America Bonds, SPACs, and cryptocurrency, just to name a few. The search for yield and income has been challenging for fixed income investors in the past fourteen years of Fed-suppressed rates. The challenge is even greater in the current context of 8.5% inflation. For some ruefully looking at the Fed and their savings accounts, the line from the Godfather resonates: “I know it was you, Fredo. You broke my heart.”
Recession Talk
Very little of what is happening in the markets can be considered cinematic in the context of the pandemic and its latest Covid variants, lockdowns in China, the war in Ukraine, threats of nuclear war and cyberattacks, bloated central bank balance sheets and skyrocketing national debts. But dissections of all the global monetary and fiscal policy responses will be made once the next cycle arrives and another recession inevitably occurs. Projections vary. A former Treasury Secretary suggested that there has never been a time when inflation was above 4% and unemployment below 5% when a recession would not occur within two years. Deutsche Bank, for one, has forecasted that a major recession is needed to bring inflation to heel. Goldman Sachs has conceded that it will be very challenging to bring down high inflation and wage growth, but stresses that a recession is not inevitable. Fannie Mae just reported that we face a “modest recession” in 2023 as a result of the Fed’s aggressive monetary policy tightening trajectory, fallout from the Russian war in Ukraine and the worst inflation in a generation.
Soft Landing Highly Unlikely
At this point, it is hard to imagine that the Fed, the Congress, and/or the White House can arrange a “soft landing” for U.S. investors and our economy. At this writing, volatility as measure by the VIX is up 31% so far in April and 57% since the start of the year. The Dow has lost more than 6% so far in 2022, the S&P 500 is down by 10%, the Russell 2000 by 13%, and the Nasdaq by 17%. Bitcoin has fallen 16%, but silver prices are up 1.5% and gold is 3.7% higher. This is all happening in the context of supply disruptions, central bank pronouncements, mixed economic data, and an uneasy political climate.
Unexpectedly High Yields
Bond prices have rapidly fallen so yields have climbed fast this year in response to market fears over the extent of future tightening measures. We less than a month into the second quarter and, at this writing, the 2-year Treasury yields at 2.69% are up 29 basis points in April and 189 basis points year-to-date. The 10-year yield at 2.81% is 130 basis points higher so far in 2022, and the 30-year yield at 2.88% has increased by 98 basis points. The 10-year Baa corporate yield benchmark at 5.03% has risen 61 basis points so far in April and 183 basis points since the start of the year.
The tax-exempt market has been particularly hard hit despite strong underlying credit fundamentals, and municipal bonds have underperformed their taxable counterparts. Municipal index returns are down 2.75% this month and 8.8% since the start of the year. The 2-year AAA general obligation muni benchmark yield has risen 196 basis points from 0.24% to 2.20% so far in 2022, 43 basis points this month alone. The 10-year yield at 2.68% is 165 basis points higher in 2022, and the 30-year yield at 3.03% has increased by 154 basis points, 52 basis points in April. The Bond Buyer points out that year-to-date muni yield increases have been among the worst on record. Outflows from municipal bond mutual funds have continued for 14 weeks, bringing year-to-date withdrawals to $44 billion, about 4% of total assets under management. Institutional bid-wanted levels are heavy at about $1.9 billion a day versus $558 million on average in 2021. We note that buy trades have nevertheless exceeded sales since January 25 and that a staggering amount of maturing and called bonds as well as interest payments are expected between May and August. More than $21 billion of principal and interest will be paid out to investors on May 1. During the summer months of June, July and August, investors will receive more than $188 billion in returned principal and $42 billion of interest, likely spurring huge reinvestment demand for tax-exempt assets. These assets have historically performed extremely well; Moody’s just reported a default rate of only 0.1% among its rated credits over the last ten years.
Current Market Context
As traders and investors, we are quite relieved for a break in the Fed chatter as Open Market Committee members are in a pre-meeting blackout period — that means no more hawkish speeches to roil markets. Lael Brainard was just confirmed as Vice Chair of the Fed, but three other nominees still await Senate action. At the next meetings on May 3 and 4, bankers are expected to hike rates by 50 basis points and repeat the process at each of the next two meetings in June and July. Some remain skeptical that markets can absorb what Fed Fund futures now prices in: 9.76 rate hikes by December with a 2.77% Fed Funds rate by year end. The recent equity market selloffs reflect great unease over the prospect of such rapid policy tightening. Markets are mainly focused on macro concerns around inflation, central bank actions, and global growth while digesting first quarter earnings reports, the latest Elon Musk/Twitter and Florida Governor/Disney news, and sagging consumer confidence and new home sales data. Traders still closely watch developments in Russia and Ukraine, and are now attuned to reactions to moves by Finland and Sweden to join NATO.
This Week in the Primary Muni Markets
Despite all the swirling uncertainty, outflows and Fed policy expectations, borrowers are forging ahead with new and refunding issues and buyers in the primary market are presenting steady demand for the slightly higher yields being offered. HJ Sims has two financings on the $15.4 billion muni calendar this week. These include a $36 million BBB+ rated refunding for Kendal on Hudson though the Westchester County Local Development Corporation scheduled for forward settlement in October. We also feature a $25.3 million non-rated sale for The Gathering Place through the Arlington Higher Education Finance Corporation. In the senior living sector, the primary slate also includes a $32.2 million nonrated refunding for Westminster Village through the Illinois Finance Authority. Other planned charter school sales include the California School Finance Authority’s $44 million BBB rated revenue bonds for Aspire Schools, and the Maryland Health and Higher Educational Facilities Authority’s $8.5 million non-rated transaction for Imagine Andrews Charter School.
Contact Us for Offers
We invite you to contact your HJ Sims representative for information on rates and offerings that you may find too good to refuse in these changing market conditions. We offer tailored investment and financing solutions for you, your family and your business. Unlike in The Godfather, when actions 50 years ago were often said to be “not personal – strictly business”, we have an 87-year history of focusing only on the personal best for our clients.
For more information on our municipal offerings or questions about current market conditions, please contact your HJ Sims representative.