By Gayl Mileszko
Market Commentary
No Do-Overs
The stock market has been vacationing in AI La-La land for quite a while, but investors swooning over today’s artificial intelligence darlings have recently had a few wake-up calls to interrupt their getaways from harsh realities. Most of these calls have come from bond market alarm clocks, buzzing, ringing, beeping, chiming, and vibrating. HEY, say the bonds, WATCH OUT: we are moving to higher ground.
Many traders on the major exchanges appear to be oblivious to the Iran war, the China-Russia alliance, the impacts of normalizing crypto, the skyrocketing sovereign and personal debt, the corporate bankruptcies at 15-year highs, the likely effects of redistricting on future elections and policy, and K-shaped everythings. AI is seen by some as an economic panacea, promising unprecedented efficiencies, and innovations. But bond investors who often consider themselves the only adults in the room ask: Don’t you see the flood of trouble around us and the bad weather headed our way? Higher food and fuel prices due to all the oil and fertilizer treading water in the Strait of Hormuz. The coming job losses due to AI. The improbability of lower rates coming from the new Fed chairman being sworn in this week. The ginormous debt financing our deficit. Fewer federal funds to spend on anything other than interest costs, Social Security, Medicare, and defense. The bond markets know that there are no easy solutions, but facts are facts. And monetary and fiscal do-overs are not possible.
Last Resort
One noteworthy wake-up, shake-up came last week but was quickly brushed off. DoubleLine Capital CEO Jeffrey Gundlach, announced his new portfolio strategy: swapping out high coupon Treasuries for lower coupon bonds of the same maturity to hedge against the possibility of a federal debt restructuring. This bond fund manager with $95 billion of assets dared to say out loud something that few outside of academia have dared: the U.S. Treasury may have to unilaterally lower the coupons on $31 trillion of outstanding Treasury debt to reduce our national interest expense and avert a debt crisis. Gundlach pointed to the massive deficits incurred over the last 25 years and the maturing debt that we must refinance at ever higher rates. He admits that this would be an extreme last resort for the government to curtail its runaway interest expense. The consequences of such a “do-over” would indeed be staggering, even talk of it is highly unsettling. So, right away, National Economic Council Director Kevin Hassett stated unequivocally that any form of unilateral coupon reduction or forced bond-swapping would amount to a catastrophic, unthinkable default and that there is not a chance in a million years that this administration would ever do anything that looks in any way like a debt default. A future lame duck president faced with foreign buyers who no longer see U.S. Treasuries as the global benchmark, the ultimate “risk-free” asset, or one acting in concert with other nations also overwhelmed by debt, may have no choice.
Municipal Credit Strength
The municipal bond market tallies about $4.1 trillion of outstanding debt, most of it issued by state and local governments required to have balanced budgets. Thirteen states currently have AAA credit ratings, higher than that of the federal government. In fact, some 10-15% of outstanding muni bonds issued by cities, colleges and others are rated triple-A. Defaults are rare in this muni sector but can certainly escalate during periods of economic distress. There are occasional periods when munis behave independently of other markets but more often than not, they follow U.S. Treasuries, no matter how strong the fundamental or technical factors for tax-exempts may be. Even in declining economic conditions, discerning investors may look to the relative strength of muni credits in situations where stocks, U.S. Treasuries and U.S. corporate bonds sell off.
Treasury Yields at 20-Year Highs
During the past week, markets monitored the President’s trip to Beijing, the ups and downs in Iran peace talks, some of the last earnings reports for the first quarter, oil prices that have risen 11%, and the 5.18% 30-year Treasury yield at its highest level since 2007. Stock market volatility has remained in a tight range while bond market volatility has spiked 25%. The 2-year Treasury yield has risen by 16 basis points to 4.11%, and it has now exceeded the Fed Funds effective rate at 3.62% since March 12. In the past week, the 10-year Treasury yield has risen 16 basis points to 4.57% while the 30-year AAA municipal general obligation benchmark yield at 4.54% is 8 basis points higher. There has been a bond selloff, and it has been global, with yields now at 20-year highs, raising the cost of borrowing for many and placing some very unwelcome pressures on stocks otherwise occupied with the big wait for Nvidia results and the prospectus for the SpaceX initial public offering, expected to be the largest in history.
Market Movers This Week
Aside from Nvidia and SpaceX, this week’s market movers likely include results from the 8 Treasury auctions, signals from four Fed speakers, the outcome of the Long Island Railroad strike, the fuel situation in Cuba, jet fuel and gasoline prices going into prime vacation season, and economic data including minutes from the last Federal Open Market Committee meeting, pending home sales, housing starts, and consumer sentiment. Muni markets will follow investor appetite for another 14 billion weeks of new issues, whether they will bring a fifth straight week of net inflows into mutual funds, and how buyers are planning to spend the $53 billion of principal and interest payments expected next month. We are monitoring progress on the 21st Century Road to Housing Act, the second reconciliation bill, the CLARITY Act and the primary results in Kentucky, Alabama, Idaho, Georgia, Oregon, and Pennsylvania. Mortgage rates remain high at 6.36%, and money market assets at $7.7 trillion sit just below all-time highs.
“Carnival of Headline Risks” but Solid Demand
Municipal Market Analytics reports that the muni market is facing “a carnival of headline risks” rendering investors somewhat numb to news events and data releases that would be unimaginable in previous years. But they note that the number of borrowers in payment default at 313 is the lowest it has been since April of 2010. Inflation obviously remains the constant worry, with no sign of abatement. It seems inevitable that energy supply shocks will soon lead to Fed tightening; futures trading now shows more than a 50% probability of a Fed rate hike in December. No cuts are forecast all the way through 2027. Although dragged down by weaker Treasury prices, higher than expected CPI and PPI and, at $216 billion, all-time high volume led by a string of billion-dollar deals, municipals are nevertheless outperforming Treasuries and corporates this year and are one of only two fixed income classes with positive index returns. And the primary calendar continues to be met with support from mutual funds, ETF inflows, and separately managed accounts. HJ Sims has been very active in the primary market of late, so we have seen first-hand the level of demand for tax-exempts.
Recent HJ Sims Senior Living and Student Housing Financings
Last week, HJ Sims brought a $69.6 million deal for The Park at South Stadium in Fresno. The non-rated revenue bonds issued through the California Public Finance Authority to finance 174 units of multifamily purpose-built student housing were structured with a 2066 maturity priced with a 6.75% coupon to yield 7.00%. We also underwrote a $34.6 million non-rated financing for Lucy Corr Village, a 341-unit life plan community in Chesterfield, Virginia. Bonds issued through the Chesterfield County Health Center Commission included a 2048 maturity priced at par to yield 6.00%. And we remarketed $30 million of BBB rated Iowa Finance Authority revenue bonds for Lifespace Communities; the bonds with a mandatory tender in 2031 were priced at par to yield 3.95%.
HJ Sims Pricing 3 Charter School and Senior Living Deals This Week
This week we are bringing a $19.6 million BB+ rated Newark Higher Education Finance Corporation transaction for BB+ rated TLC Academy, a network of five PreK-12 charter schools in North and West Texas with 4,096 students. We also have a $12.7 million Sierra Vista Industrial Development Authority issue for BB rated Champion Schools, a PreK-8 charter school that has been educating students in the Phoenix area since 1999. And we have a $206.3 million non-rated financing for a 177-unit start-up rental senior living community in Tucson to be known as Endeavor Catalina Foothills; the non-rated deal is coming through the Tucson Industrial Development Authority.
This graduation season once again stretches from May through June, and HJ Sims congratulates all those receiving high school, undergraduate, and graduate degrees. We celebrate their achievements and commend the parents, family and friends who provided support during their many years of study. We invite new graduates continuing with their educational or career journeys to contact an HJ Sims representative for investment guidance to establish a good discipline early on and hopefully avoid some of the do-overs often needed when proceeding without professional guidance. We also wish our readers a happy and safe Memorial Day as we honor the brave men and women in uniform who sacrificed their lives to ensure our freedom to pursue dreams and achieve success.