Market Commentary: Hunga Tonga

by Gayl Mileszko

“Hunga Tonga”

The COVID-19 pandemic first reached the remote South Pacific Island nation of Tonga in late October of 2021 but was quickly and blessedly contained. The 106,000 residents of the kingdom had been watching and reading about the horror befalling millions on the mainland for nearly two years. Their sighs of relief and prayers of gratitude were, unfortunately, short lived. A disaster far worse than that threatened by a single air traveler arrived. It came from below, 490 feet below, starting in December with a rumble on Hunga Tonga-Hunga Ha’apai, a submarine volcano in the 171 Tongan island chain, which erupted with a massive force on January 15, 2022.  The eruption sent 146,000 metric tons of super-heated water not only into the stratosphere but into the mesosphere for the first time in recorded history, an unprecedented amount, perhaps influencing atmospheric chemistry and the climate of our planet for many years.

Hundreds of Times more Powerful than Hiroshima Bomb

On top of the water, the amount of rock, ash and sediment displaced in the eruption generated the largest atmospheric explosion recorded by modern instruments, one that was heard as thunder more than 1,200 miles away two hours later, and then as booms in Vancouver, six thousand miles from the epicenter. Thousands of flashes of lightning were recorded, and tsunamis in New Zealand, Japan, Chile and Peru occurred. Shockwaves were reported as having gone around the Earth as many as four times.  NASA determined that the eruption was equivalent to five to thirty tons of TNT, hundreds of times more powerful than the atomic bomb dropped on Hiroshima 78 years ago this week on August 6, 1945.

Just Another in a Series of Unprecedented Shockwaves

Very little has been reported about this remarkable climate event because we have had millions of other worries. Citizens of the world are alarmed by the talk of nuclear weapons being threatened by Russia, and we are very tired of all the natural traumas, unprecedented interventions, and man-made terrors in the daily headlines. A long, peaceful break would be great, but alas one is not in the cards. Many across the world exist in circumstances entirely inconceivable to those of us who are more adversely affected by central bank decisions and the fiscal policy actions of our elected leaders than by starvation, war crimes, and persecution. The worst worries that we of many blessings in the U.S. have been generally focused on gas prices and mortgage rates, taxes, college costs, flight cancellations and retirement savings.

Fitch Lowers the Boom

The surprise downgrade in the credit rating of the United States from triple-A to AA+ by Fitch Ratings on Tuesday afternoon has not shocked the markets so far, but investors are still digesting the news and considering the ramifications.  The rating agency has had the sovereign credit under review since the debt ceiling debate heated up and a U.S. default was being discussed.  Indeed, the analysts at Fitch cited the “erosion of governance” on fiscal and debt matters relative to other sovereign peer credits in its justification. There were plenty of other reasons, including the fiscal deterioration they expect over the next 3 years due to weaker federal revenues, new spending initiatives and a higher interest burden; the government debt that has been growing over the last 10 years; the lack of a medium term fiscal framework; limited progress in tackling challenges related to an aging population such as funding the Social Security and Medicare programs created 58 years ago this month; and the increased vulnerability of our fiscal position to future economic shocks. All of this was offset by two brief sentences extolling our strengths: our dollar as the world’s preeminent reserve currency and our well-diversified and high-income economy supported by a dynamic business environment.

Exploding Debt

The downgrade is a prime topic of discussion across the country and plenty of fingers are being pointed, but no action is being taken right now. We are in the heart of the summer, the President is on vacation, the House has adjourned until September 12 and the Senate is out until September 5. The federal fiscal year ends on September 30 and there will likely be another standoff on spending.  Our federal debt is at $32.6 trillion and climbing; in the first nine months of this fiscal year alone, as the Fed benchmark rates have risen from 0.25% to 5.50%, the cost of servicing our federal debt has risen by 25% or $652 billion.  We plan to sell the better part of $1 trillion in the coming months to foreign and domestic investors, at rates they dictate at auction, to cover our current debts. Our federal budget deficit is now close to $1.6 trillion.

Comparing Credit Strengths

In context, the total market capitalization of the U.S. stock market on June 30 was $46.199 trillion. The U.S. bond market is valued even higher — at over $51 trillion, with $25 trillion in U.S. Treasury securities outstanding. U.S. GDP totals $26.8 trillion and our potential is only limited by the energy, innovation and productivity of Americans. It is nevertheless unsettling to have anything less than the highest credit ratings. Although Moody’s and Kroll Bond Rating Agency still assign stable AAA/AAA ratings, Fitch has joined S&P, which issued its downgrade in 2011, in evaluating the long-term U.S. as AA+, below that of Luxembourg, Johnson & Johnson, the state of Iowa, and the University of North Carolina at Chapel Hill.

Call to Discuss Ramifications

It is unlikely that the announcement by Fitch will trigger major adjustments in state, local and corporate credit ratings. Treasury auctions are not expected to be significantly impacted. We have endured recessions, a pandemic, sky-high inflation, bank failures, cyberattacks, rate increases, drought, floods, wildfires, heat waves, spy balloons and more this year, so investors are by no means thin-skinned. But investors cannot help but wonder how the federal downgrade impacts the perceived value of municipal bond holdings, and if long-term bonds issued to finance projects reliant in part upon federal support are imperiled. Borrowers in the municipal and corporate markets, where pricing is referenced in terms of spread to the 10-year and 30-year Treasury yields, may wonder if investors will now demand more of a risk premium.  These and other questions are welcomed by the investment bankers and private wealth group at HJ Sims. Reach out to your HJ Sims representative to discuss market conditions as they evolve.

Other Market Movers This Week

This week, investors are looking at several other market movers. While keeping an eye on the outcome of the six scheduled Treasury auctions and the remarks being made by three Federal Reserve officials, traders are closely following the second quarter earnings reports coming from about one third of the companies in the S&P 500. Investors are gauging the impact of the new Chinese export restrictions being imposed on gallium and germanium, both used in the production of semiconductors. There are also several key economic indicators being reported, including job openings, payrolls, senior loan officer opinions, manufacturing, construction spending and factory orders. Developments with presidents, past and present, only contribute to uncertainty.


Investors uncertain about the direction of the markets continue to place their cash in the most liquid instruments. Last week, $28.8 billion flowed into money market funds, and yields broke the 5% level on average for the first time since 2007 according to Crane Data. Higher yields were also available in the municipal market. During July, the 2-year yield rose 24 basis points to 3.17%, the 10-year at 2.57% increased by 1 basis point, and 30 years at 3.51% closed 2 basis points higher. HJ Sims sold $5.38 million of non-rated draw down bonds through the Illinois Finance Authority for the Clark Lindsey community in Urbana. One series due in 2028 priced at par to yield 6.27%, and the second due in 2032 priced at par to yield 6.50%. Also in the senior living sector, the California Statewide Communities Development Authority issued $67 million of insured bonds for Odd Fellows Home of California. The final maturity for the AA-minus rated bonds was priced at 4.125% to yield 4.28%. In the charter school sector, Michigan’s Charyl Stockwell Academy brought $7.8 million non-rated financing with a single 2052 term bond priced at 7.00% to yield 7.42%.

July Returns and August Preview

Treasury returns in July, as reflected in the ICE BofAML index, came in at negative 0.40%, while the investment grade muni index was positive at 0.25%, the high yield muni index returned 0.46% and taxable munis had a negative 0.86% return. BBB rated bonds and bonds in the 12–22-year maturity range turned in the best performance, but bonds across the board paled in contrast to all stock market indices. The Nasdaq gained 4.08%, the Dow was up 3.44%, and the S&P 500 returned 3.21% on the month. We are now into the first few trading days of this month and our banking, underwriting, trading, sales and analytic teams remain active in the primary and secondary municipal markets. There may be some volatility linked to the downgrade, and there is always the possibility of an unexpected event as with Hunga Tonga, but otherwise we expect a solid month.  A total of $50 billion of principal and interest will be paid to bondholders in August, the largest monthly level of redemptions and coupons in 2023. Muni fund flows have been positive for the past two weeks. New issue volume is down more than 13% from last year, so there is scarcity value in tax-exempts. At this writing, the 1-year AAA general obligation bond yield stands at 3.21%, higher than the 17-year maturity at 3.19%. On the government side, the 6-month Treasury at 5.49% remains at the peak of the inverted curve. The 2-year bill yields 5.40%, the 10-year note stands at 4.09% and the 30-year bond is at 4.18%. Contact your HJ Sims representative this week to help find the best yields, income, and terms to meet your needs.