HJ Sims Market Commentary: All is Calm, All is Bright?

by Gayl Mileszko

Treasury Secretary, Janet Yellen appeared on 60 Minutes this past Sunday to present her views on the state of the U.S. economy, the risk of recession and the widespread costs of Russia’s war against Ukraine. Ending that war, she contended, would be the single best thing we can do for the global economy but, until then, the U.S. will continue to fund Ukraine for “as long as it takes”. As for America, the nation’s 78th Secretary presented a rather rosy outlook for the coming year, one in which, absent an unanticipated shock, inflation will be “much lower”. She noted that the labor market remains healthy, and many of the underlying causes are being resolved. Shipping costs have come down and delivery lags have shortened. Gas prices are way down, she said, and our banking system, business and household sectors are “very healthy”. While admitting that economic growth is slowing and there exists risk of recession, the Secretary does not believe that one is necessary to quash inflation. Her hope is that conditions will enable people to “feel good about their finances and their personal economic situation.”

Vigil Ahead of the Fed Monetary Policy Meeting

Yellen’s interview came after the Producer Price Index report reflected an increase of 0.3% in November and 7.4% over last year but before the latest Consumer Price Index data showed that prices rose only 0.1%, less than expected, recording the smallest monthly increase in more than a year. Financial markets largely shrugged off the hot number and embraced the soft one, initially rallying Monday on the belief that conditions are at least improving, if not bright, paving the way for the Federal Reserve to slow the pace and size of rate increases, beginning with Wednesday’s policy committee meeting. For the past month, traders have been anticipating a smaller 50 basis point increase. This week, they have been keeping a quiet vigil ahead of the FOMC announcement, dot plot, and press conference.

Stock and Commodity Markets Ruffled

The economy is prone to shocks, as Secretary Yellen pointed out, and markets always attempt to brace for the unexpected. But in the case of the Fed, officials have been omnipresent and quite vocal, pretty clearly telegraphing their views, concerns and likely action. Nonetheless, some uncertainty prevails amidst the mixed economic data, so markets are not calm. Many investors see that there is still an awful long way to go to get from the prevailing 7.1% inflation rate to the 2% Fed target. So despite the Cabinet Secretary’s spin and pre-holiday cheer, volatility is higher this month: the VIX Fear Index has risen 21% since the start of December, and the MOVE Index, reflecting Treasury market volatility, is up more than 11%. The Dow at 34,005 has fallen 1.7%, the S&P 500 at 3,990 is down 2.2%, the Nasdaq at 11,143 has declined 2.8% and the Russell 2000 at 1,818 is 3.6% lower. Oil prices at $73 a barrel are down 9.2% while Bitcoin at $17,011 is up 1.3%, gold at $1,783 is 1.7% higher, and silver at $23.22 has increased 7.3%. 

Bells in the Bond Markets

The government market is reflecting a much greater fear of recession than the Treasury Secretary. The yield curve turned upside down in early July and is now deeply inverted. At this writing, the 2-year Treasury yield at 4.37% is 76 basis points higher than the 10-year at 3.61% and 80 basis points higher than the 30-year at 3.57%. The 3-month and 12-month bills each exceed the 10-year and 30-year bond yields. The brighter notes are in the corporate and muni markets. The 10-year BAA corporate bond yield has fallen 28 basis points so far this month and municipal benchmarks have also strengthened. The 2-year AAA muni general obligation bond yield at 2.46% has fallen 7 basis points. The 10-year at 2.51% is down 20 basis points, and the 30-year at 3.46% is 6 basis points lower.

Municipals A-Leaping

Municipal bonds have been in rally mode for more than a month.  Issuance is running well below projections as well as prior years while demand from retail buyers for individual credits as well as exchange traded funds continues to bolster the performance of the asset class. Yields have, for the first time in many years, become attractive, new issues and secondary market offerings are for the most part available at good discounts, and credit quality relative to similarly rated corporate securities is high. However, year-to-date returns are posting historic losses:  major investment grade and high yield indices are down 8.00% to 9.00%. These unusual losses have presented bondholders with the opportunity to harvest losses and swap individual bonds and mutual fund holdings into highly liquid, low-cost municipal exchange traded funds. Buyers have added $27.8 billion to ETF assets so far in 2022, boosting assets under management across the 72 separate funds to $105 billion, while withdrawing more than a combined $130 billion from the 541 conventional mutual funds.

Tax-Exempt Sugar Plums

Those investors sitting on cash with access to new issues are finding good yields. Last week, the Public Finance Authority of Wisconsin sold $38.1 million of BBB-minus rated education revenue bonds for Triad Math and Science Academy in Cary, North Carolina; the final maturity was priced at 5.50% to yield 5.57% in 2062. The Authority also brought $185 million of non-rated project revenue bonds for Provident Group’s Los Cielos Development structured with a 2057 term bond priced at par to yield 7.25%. The City of Chicago came to market with $523.8 million of Baa3 rated bonds including a 2043 term bond priced at 5.50% to yield 4.83%. This week, the tax-exempt primary calendar totals less than $4 billion and there are very few high yield offerings. These include an $18.5 million non-rated Hampton, Minnesota offering for Praha Village and a $4.4 million Illinois Finance Authority financing for non-rated Legacy Charter School in Chicago.

Holiday Hiatus

There are technically 12 trading days left in the year, but activity has begun a marked slowdown ahead of the holidays. Many investors are simply looking to avoid any more trouble or loss and put 2022 behind them. Some simply want to step back and celebrate the joys of the season. If you are actively trading, looking for guidance ahead of the New Year, or closing your books a little early, keep your HJ Sims representative apprised. We welcome your calls all year round.

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