Market Commentary: Déjà vu All Over Again

by Gayl Mileszko

Déjà vu All Over Again

In the major league political ballpark of Washington, D.C., Yogi Berra would point out that it is “Déjà vu all over again.”  Funding for the new federal fiscal year begins on October 1 and the Congress has not come close to agreeing on FY24 spending – not even for one small agency like the Marine Mammal Commission and its 12 employees.  The House and Senate are not yet even able to agree on a short-term extension of funding at current levels to give themselves more time to work out their differences. The differences, at this writing, appear so vast that much of the U.S. government will close on Sunday at 12:01 am. and remain closed until pressures from constituents, lobbyists, investors, rating agencies, media and those seeking food and housing assistance, tax refunds, or services at national parks finally bring those in key roles to the table to produce a compromise, at least for the short term.

How A Shutdown Plan Would Impact Essential and Non-Essential Federal Employees

It would not be the first time that the Office of Management and Budget would activate plans and instructions to shutter parts of 440 federal departments and agencies involving 4 million federal employees. The Congress has not passed all 12 separate appropriations bills on time in 26 years, and there have been 14 occasions since 1980 when parts of the government have shut down. During these periods, ranging from one day to 34 days, essential personnel are differentiated from the non-essential ones, proving fodder for comedians and legislators looking to pare federal spending.  Essential employees who will not be paid until the government re-opens must show up for work; these include active-duty military, federal law enforcement officers, air traffic controllers, accident investigators, intelligence officials, firefighters and power grid maintenance workers. There are also thousands of workers in Social Security, Medicare and Medicaid, veterans care, and mail delivery who are not funded with taxpayer dollars and therefore not affected by a shutdown. Members of Congress, the President, and all appointed justices will continue to receive their pay, while about 380,000 non-essential personnel are furloughed, including approximately 94% of the Securities and Exchange Commission and 600 Commodity Futures Trading Commission staff. 

Impasse Raises Governance Issues Once Again

There are a host of issues that divide House Republicans, Senate leadership, House and Senate members, Congress and the White House, Republicans and Democrats. With respect to the spending bill in the limelight, thorny matters involve Ukraine funding, defense levels, border security, corporate tax cuts, child tax credits, and disaster relief, among others. But there are always major differences that get worked out in small conference rooms ahead of or soon after urgent deadlines.  The divisions appear particularly sharp this year within the House Republican Conference and threaten the power of its leaders. Members were at odds earlier this year over the raising of the debt limit, but a suspension through January of 2025 was eventually agreed upon in exchange for capping funding on certain federal programs. The stalemate, the fiscal deterioration, and the growing debt burden raised governance issues once again in the eyes of Fitch Ratings, and that led to a downgrade of the U.S. sovereign credit for a second time. Wall Street, which is gauging the extent of the current impasse, is anxious to avoid a third downgrade by Moody’s Investors Service.

No Surprise: Public Views of Elected Officials Unrelentingly Negative

Diversity of opinion and freedom of speech are hallmarks of America. But our history includes a civil war and recent secession efforts by some in eastern Oregon, Staten Island, northern California, western Maryland, southern Illinois, and northern Colorado. Pew Research Center has reported on the sizable gaps in the share of Americans who say that we are not doing well in living up to principles respecting the rights of people, offering an equal opportunity to succeed, and ensuring that elected officials face serious consequences for misconduct. Our views of politics and elected officials are “unrelentingly negative”. Majorities say that the political process is “dominated by special interests and flooded with campaign cash and mired in partisan warfare.” Elected officials, according to Pew, are widely viewed as self-serving and ineffective. Just 16% of the public say that they trust the federal government always or most of the time. Reflecting the 24/7 nature and influence of mainstream and social media, the majority believe that conflicts between Democrats and Republicans receive too much attention. The vast majority say that there is too little focus on important issues facing the country.

One Eye on DC But Major Focus on The Fed

The financial markets of course closely follow the goings-on in Washington. Wall Street veterans have seen plenty of occasions when the White House, the House, and the Senate are at loggerheads but eventually reach consensus. The heightened volatility and recent selloffs in stock and bond markets are not so much a reaction to the prospect of a partial government shutdown this time. In fact, banks and brokerages would love to see many regulatory agencies in mothballs for the rest of the year. The central focus of investors remains on the Federal Reserve and its next rate decision.

Impact of a Shutdown on The Fed

Markets sold off after last week’s Federal Open Market Committee meeting where benchmark interest rates were not raised or lowered but continue to sit at a 22-year high. Indications are that there will be at least one more hike on November 1 or December 13.  How would the Fed be affected by a shutdown?  As an independent agency, the Fed was created to be self-financed and not subject to the congressional budgetary process. As it happens, the Fed has been operating at a loss since September 2022.  This is because its interest-bearing liabilities have higher yields than its interest-bearing assets. So far this has not affected market or public perceptions or confidence. But in a government shutdown, members and staff of the FOMC would have only limited access to key inflation data as the staff at the Departments of Labor and Commerce. Staff which produce the personal consumption expenditures and consumer price index data will be on furlough and not reporting. A Bank of America economist suggested that the Fed would be “flying blind” without these key inputs on economic activity and price pressures. If the impasses last more than a month, its most prudent course may be to stay on hold.

Worries and Opportunities Going into the Fourth Quarter

This is the final week of September and the end of the third quarter. Investors have more than the usual share of worries and opportunities going into year-end.  Food and energy inflation still afflicts households and businesses. Higher interest rates continue to weigh down the economy. Student loan payments resume next month, and pandemic child tax credits and rental assistance is coming to an end. U.S. Treasury borrowing proceed apace with 10 auctions scheduled this week totaling $364 billion in just these first three days. The national debt has soared to $33.04 trillion. Seven Federal Reserve officials are on the speaking circuit. A host of housing data will be reported along with durable goods, jobless claims, consumer confidence and sentiment. Hollywood writers have returned to work, but actors are still on strike, as are about 19,000 of the 150,000 United Auto Workers; 60,000 Las Vegas hospitality workers have also just voted to authorize a strike against 22 casino resorts. The U.S. House of Representatives Committee on Oversight and Accountability will hold its first impeachment inquiry hearing on Thursday. Former President Trump has been found liable for fraud for exaggerating his net worth and faces a non-jury trial on New York’s claims including falsifying business records and issuing false financial statements. And the second Republican presidential debate involving seven candidates, and more than a dozen major issues takes place on Wednesday night.

Volatility Sends More Assets into Liquid Money Market Funds

With only a few trading days left in September, investor mood as measured by the CNN Fear and Greed Index has reversed completely from “greed” to “fear.” Money market fund assets remain near record highs at $5.63 trillion and retail money funds have a 7-day yield of as much as 5.47%.  Stock market volatility as measured by the VIX Index is up 38% this month.  The S&P 500 index is down 5.1% this month but posts a 13.8% return year-to-date. In the commodity sector, oil prices at $93.03 a barrel have risen 11% this month, gold at $1,884 is down 3%, and Bitcoin at $26,191 is nearly flat.

Attractive Bond Yields but Unattractive Returns

Bond market volatility as measured by the MOVE Index is 9% higher month-to-date. Treasury yields are still partially inverted with the peak yield at 5.56% in 6 months, well above the 30-year at 4.69%. The 2-year Treasury yield at 5.08% has increased 22 basis points in September. The 10-year at 4.55% is up 45 basis points, and the 30-year at 4.68% is 47 basis points higher.  Treasury index returns remain negative this year at -1.03%. The 10-year BAA corporate bond index yield at 6.76% is up 27 basis points and high-grade corporate bonds indices are up 1.48% in 2023.  High yield corporate bond indices are performing better at +6.42%.

Municipal Bond Market Update

In the tax-exempt market, bonds have been weighed down by hawkish Fed statements indicating “higher for longer”, higher oil prices, cheaper Treasuries, and a heavy reliance on household demand as conventional municipal bond mutual funds have seen outflows for 8 straight weeks, fund buyers are mostly on the sidelines, and banks and insurance companies have reduced their holdings.  Primary market supply is down about 13% from last year. Bids-wanted par remains elevated, as are offerings, as buyers look to swap into higher yielding bonds. The 7-day SIFMA municipal bond index yield stands at 4.31%. The 2-year muni yield at 3.54% has risen 40 basis points this month. The 10-year AAA general obligation bond benchmark yield at 3.31% is up 38 basis points. The 30-year yield at 4.22% has increased 34 basis points. Investment grade muni indices on the year are just positive at 0.38%.  High yield munis are up 1.48% and taxable munis are up 1.19%.

HJ Sims Brings Southwest Charter Foundation to Market

In the new issue muni market, HJ Sims just brought a $32.1 million non-rated draw down financing through the Capital Projects Finance Authority in Florida for Southwest Charter Foundation.  We structured the financing with a 2030 term bond priced at par to yield 7.25% and sold in $250,000 denominations.  So far this calendar year, we have seen 63 charter school financings totaling $1.4 billion, 43% of which were non-rated. In the senior living and care sector, we have seen 21 transactions with combined par of $1.1 billion.

Make the Most of the Fourth Quarter

The fourth quarter is a great time to review your portfolio with your HJ Sims representative.  Municipal bondholders will see $32.7 billion of principal and interest hit their accounts on October 1 and we stand ready to assist with reinvestment options.  Schools, hospitals, and senior living and care communities are also welcome to contact our investment banking team for current market conditions and guidance. We have been investing since 1935 in various déjà vu conditions and stand ready to help our clients navigate through political, economic and market uncertainties.  Reach out to us this week to share your concerns, interests and needs.