Market Commentary: Fifty-Fifty

by Gayl Mileszko


Coin flips are used to decide everything from who gets first possession of the football to major life moves like quitting a job or moving across the country.  Last November, two local Kentucky races, one for city council and one for magistrate, ended in a tie; after recounts, the candidates agreed to abide by the result of a coin toss. In both cases, the one who called “Heads” won.  Some argue that each contestant had an even chance of winning. But 50 European academics researching this form of tie-breaking believe they have just proven otherwise. After performing tests involving a staggering number of flips (350,757), they found that a small degree of precession, or wobble, is introduced into the coin as it tumbles through the air. The wobbling causes one side to spend more time facing up. And the more time it spends facing up — however small — the more likely it will be in that position when it lands. With some variance between the persons performing the flip, researchers concluded that coins landed on the same side they started on 50.8% of the time. It may not seem like much of a difference, but the authors of the study put it this way: if you bet a dollar on the outcome of 1,000 flips, knowing the starting position of the coin would earn you $19 on average.

Glass Half Full and Half Empty

It feels like a fifty-fifty world right now in so many respects. News stations are being inundated with complaints over their coverage of the Hamas-Israel war. The BBC just reported that the complaints are split 50-50. In looking at the bloody ground wars in Gaza and Ukraine, Hedge fund billionaire Ray Dalio just put the odds of a “hot world war” erupting at 50%. Just about fifty percent of Americans polled are “very concerned” that the war in Gaza will escalate into a wider war in the Middle East. An equal number see the greatest threat to the U.S. coming from China.  The great divide appears in many other aspects of American life. About 49% of Americans disapprove of professional athletes using their platform to express social and political views. We are evenly divided in our plans to receive or skip the updated Covid-19 booster shot. Nearly half of young adults aged 18 to 29 are living with their parents, roughly the same level as the 1940s. Women now outnumber men 50.7% to 49.3% in the U.S. college educated labor force. Fifty percent of adults live in middle class households. Roughly half of us find it acceptable for DNA testing companies to share customers’ genetic data with law enforcement agencies to help solve crimes. Forty-nine percent of Americans say they would rather have a bigger government providing more services. Economists recently surveyed by the Wall Street Journal have lowered their estimated probability of recession to just below 50%.

Dots Point to 5.50%

While the financial press portrays the Federal Open Market Committee as fairly evenly split on the need for another rate hike this year, the minutes from the last meeting in September show that 12 of 19 indicate that one or more increases would be needed before year-end.  Fed officials are on the public speaking circuit this week presenting their views at 20 different events. This is an unusually high number of appearances, but business, academic, and investment groups are clamoring for insight on when rate cuts will start. The universal sentiment seems to be that we are in an abnormal rate environment and that levels will eventually go back toward zero. But one of the last major studies of 5,000 years of interest rate history going back to the Late Bronze Age was recently cited by Bank of America Global Research and it showed that 5 percent yields have been pretty much the norm for the last 250 years. We note that the average 10-year Treasury yield over the past 50 years is 5.96%; it currently stands at 4.86%. The fifty-year average yield on the 30-year bond is 6.22%, well above the current level at 4.97%. Where do we go from here?    The bond market leads the way, but much attention will be given to Chair Powell’s speech to the Economic Club of New York on Thursday. It is his last chance to send a signal to all markets ahead of the policy meeting that begins on October 31.  The Fed is about to enter into a blackout period which limits the extent to which members and staff can grant interviews starting on the second Saturday preceding an FOMC meeting and ending the Thursday after.

What To Expect on November 1

Central bankers will re-exhaust discussions on the economy, jobs, inflation, retail sales, consumer expectations, industrial production, and housing.  They will review the latest weak U.S. Treasury auction outcomes amid the tightening efforts which are reducing their own holdings of Treasuries by $30 billion a month. Current futures trading points to an 89% probability that target rates will remain in the range of 5.25% to 5.50%. Then, as predictable and cliched as a Taylor Swift song, the November statement will note that “The U.S. banking system is sound and resilient…. The Committee is strongly committed to returning inflation to its 2 percent objective… The Committee will continue to assess additional information and its implications for monetary policy …. The Committee would be prepared to adjust the stance of monetary policy as appropriate if risks emerge …”.

Growing Interest in Interest

Despite notably higher yields, there has been a pullback in demand for 10- and 30-year governments as expectations for inflation remain elevated and concerns grow over escalating interest costs and Washington’s lack of attention to the soaring federal deficit and debt. There is no doubt that Members of Congress will soon wake up to the fact that the cost of servicing our debt is increasingly eating into favorite discretionary spending programs. Interest expense totaled $475 billion in FY22 but in August the U.S. Treasury reported that it rose to $808 billion, or 15% of total federal spending. The CBO projects that spending on interest costs will rise to $1.4 trillion by 2033, exceeded only by Medicare and Social Security spending.

Yields Up Well Over 50 Basis Points in 2023

The same rates afflicting interest expense on our public debt are a growing source of delight to bond investors. The expectation that inflation and market volatility will remain with us for the near future is producing yields not seen since 2006. At this writing, the 6-month Treasury still has the highest yield of all government maturities at 5.59%. The 12-month yield is 5.46%. The 2-year stands at 5.19%.  Money market funds, largely invested in short Treasuries, are at all-time highs. The average annualized 7-day yield of the 100 largest MMFs is 5.17%. PNC Financial just came to market with an A3 rated senior unsecured 10-year bond with a 6.875% coupon and a 3-month par call.  Thirty percent of the Bloomberg US Corporate High Yield Index yields more than 10%.

Municipal Market Yields and Issuance

In the tax-exempt market, the 1-year AAA general obligation municipal bond benchmark yield is 3.70%. The unprecedented 11-month inversion of the short end of the municipal bond yield curve has the 10-year muni yield 21 basis points lower at 3.49%. The 30-year muni yields 4.42%. HJ Sims was in the market last week with the $44 million non-rated financing for Renaissance Charter School, structured with four term bonds, including a 30-year maturity priced at 6.75% to yield 6.85%. Also in the charter school sector, the Colorado Educational and Cultural Facilities Authority sold $49.7 million of non-rated revenue and refunding bonds for Pioneer Technology and Arts Academy with a 2030 term bond priced at 7.43% to yield 7.555%. Retail demand for higher yielding bonds has been strong. We are seeing heavy trading in smaller blocks in the secondary market as individual accounts swap old bonds for new ones to harvest tax losses and boost portfolio performance. Retail is also withdrawing investments in municipal bond mutual funds as NAVs drop in the higher yield environment; there have been 11 straight months of outflows. This has had an impact on the overall performance of the market. So too has the lack of participation by banks and insurance companies; both have been net sellers this year for different reasons, but their absence is noted as issuance picks up. This week’s calendar is expected to exceed $12 billion.

Volatile Conditions Present Countless Opportunities

Financial markets have lots to grapple with this week.  Oil supply and prices have climbed up on the “wall of worry” alongside fears of an escalation of the war in Gaza. Iran has stepped up its rhetoric and called for an Israel oil embargo by Muslim nations. The Russian President is in a sign of deepening relations and the effort to create a new world order. The House of Representatives have not had a speaker for two weeks and Tuesday’s vote showed no progress in electing one. U.S. economic data has been beating expectations, raising fears that the Fed may tighten further. Treasury auctions continue apace, with eight this week, raising concerns about the size of domestic and global appetite for U.S. paper. The President has directed 2,000 U.S. noncombatant troops to prepare for possible deployment to support Israel. Some of the largest U.S. corporations are releasing third quarter corporate earnings this week as one with a household name and $3.3 billion of bond debt, Rite Aid, declared bankruptcy. Chapter 11 bankruptcies jumped 68% in the first half of this year and S&P Global Market Intelligence has recorded 459 bankruptcy filings as of August 31. Amid all these changing conditions, HJ Sims is finding dozens of opportunities every day for our clients. Don’t wobble but reach out and call your HJ Sims representative today to discuss your needs and concerns and how we can help you address them.