Market Commentary: Putting Socks on an Octopus

by Gayl Mileszko

On Capitol Hill, yeoman’s work is needed to achieve consensus on the thorniest of issues, the legislative product of the most contentious of negotiations. This week, the whips on both sides of the aisle and in both chambers of Congress are hard at work trying to rapidly round up votes for a bill that will suspend the debt limit, set some new federal spending guidelines and address other issues that have, for various reasons, suddenly fallen under the umbrella of extreme urgency. It is not unlike the annual effort to enact a budget framework and then an omnibus spending bill. The whole process is described as being like trying to put socks on an octopus.

Banks, Borrowers and Investors Have Their Own Struggles

Central banks around the world understand the octopus analogy as they have attempted to battle inflation, unemployment, bank runs and various fiscal policy excesses. Borrowers across the gamut of sovereign, corporate and municipal spectrum can relate as they have tried to navigate market conditions reflecting rate uncertainty, buyer hesitancy, massive moves to safe havens, currency volatility, inflation and rapidly maturing debt. Investors deal with it every day, juggling capital and income needs with worries over recession springing from monetary policy errors, unusually attractive very short haven yields, fear of missing out, fear of holding on, fear of defaults, concerns over deeply divided government, the Russia-Ukraine war, wobbly regional banks and a Treasury yield curve that has now been inverted for the longest period of time in 43 years.

The Messy Process of Getting There

Wall Street and Main Street are convinced that the nation’s bills will all be paid on time through the next presidential election cycle although the process of getting there is not designed for those who clutch pearls at every report that one extreme clique or another will vote down the compromise. Few traders actually believe that the crisis will require the Treasury to prioritize debt service over other payments on or about June 5 because these types of votes always come down to the wire and there is always a stream of revenue. But, nevertheless last week, US Treasury bonds maturing within 2 weeks were trading at yields as high as 7%. Money market funds, which took in $46.7 billion last week, routed much of this cash into the T-Bill maturing on May 30, just in case. Treasury auctions were reported as having strong participation, but questions arose about the possible need to postpone the next few sales if the debt limit is not raised or suspended in time. The Treasury does everything possible to maintain regular and predictable auctions; only about six auctions or announcements have been delayed since 1995, according to the U.S. Government Accountability Office, and each introduced marked uncertainty into the government market.

New Worries, Old Concerns

Looking beyond the enactment of the bill suspending the debt limit, investors have concerns that Fitch and/or Moody’s could yet downgrade the U.S. rating a notch to the AA+ level. S&P made such a move 3 days AFTER the contentious 2011 debt limit debate was resolved, lowering our sovereign debt rating below that of Australia, Luxembourg, Singapore and the European Union. Fitch and DBRS Morningside placed the credit of the U.S. on negative watch last week. Corporate borrowers, European banks in particular, have been rushing to market to get ahead of the tsunami of Treasury debt that will be issued once the floodgates are opened again. Approximately $1 trillion of Treasuries will be issued by the end of September to replenish the coffers that have been drained since January. This level of sales can certainly raise liquidity issues with some banks and overwhelm other high-grade calendars. All of this presents plenty of challenges and opportunities for borrowers and investors.

Communication Lesson: Seven Times Seven

Goldfish, we are told, have an attention span of nine seconds. The octopus has a total of nine brains, including a mini brain in each of its eight arms, so it may turn its focus to many things at once. But, due to technology, our human brain is bombarded with so much information during the day that we are only good for eight seconds at a time, perhaps less after COVID and the pandemic lockdowns downsized our memories. And it certainly takes more than once to effectively get your message across whether it is to your own family members, employees, clients, neighbors or service providers. In fact some believe that it takes a total of seven times across seven forms to make sure that your message is received. House Speaker Kevin McCarthy has been one of the most visible and vocal examples of this kind of messaging during the debt limit debate. Anyone with a TV, radio, email address, phone, text, social media account, or magazine subscription knew exactly where he stood and what he wanted. Whether or not you agreed with his position, he certainly got your attention more than seven times in seven ways, and that may be a lesson worth remembering.

The Bottom Line for Markets in May

On a month-to-date basis, heading into the Memorial Day holiday, stock market volatility as measured by the VIX increased by 14%. The Dow finished down 2.9% while the S&P gained 0.9% and the Nasdaq was up 6.1%. Oil prices fell 5.4%, gold was down 2.2%, silver lost 7% and Bitcoin dropped 8.5%. NVIDIA and artificial intelligence were the words on nearly every investor’s lips as the company’s stock soared closer to $1 trillion. Bond market volatility in May as reflected in the MOVE Index rose above 18%. The 2-year Treasury yield closed Friday at 4.56%, 56 basis points higher than where it began the month. The 10-year yield rose 37 basis points to 3.79%. The 30-year at 3.96% moved up 29 basis points. The 10-year BAA corporate benchmark yield increased by 41 basis points to 6.38%.

Municipal Market Activity

Municipal bonds have outperformed their taxable counterparts but nevertheless weakened in the latter half of the month and may be facing the worst May on record since 1986. The 7-day SIFMA Municipal Swap Index yield rose to 3.41% last week. The 2-year AAA general obligation yield at 3.15% increased by 46 basis points this month. The 10-year at 2.72% is 37 basis points higher in May. The 30-year benchmark at 3.62% has risen 23 basis points. The difference between the 1-year AAA benchmark yield and the 30-year yield narrowed to 26 basis points last week, perhaps the closest on record. Major investment grade index returns are down 1.51% on the month at this writing, high yield indices are down 1.20% and taxable indices are down 3.29%. In the primary market last week, we saw $6.8 billion of transactions. The slate included a $2.1 million BB+ rated California School Finance Authority deal for Partnerships to Uplift Communities charter school refunding that featured 2047 term bonds priced at 5.50% to yield 5.60%. The California Municipal Finance Authority brought a $61.3 million financing for the Aldersly Retirement Community in San Rafael; the insured revenue and refunding bonds rated AA- had a final maturity in 2053 that priced at 4.25% to yield 4.50%. This week, the muni calendar totals $6.1 billion. Approximately $32 billion of principal and interest payments will hit accounts on June 1, but there is little in the high yield sector. A few high yield senior living and charter school deals are listed on day-to-day status as is a $742 million non-rated financing for the acquisition of five behavioral hospitals in California, Nevada and Texas by QCF Behavioral Hospitals through issuers in Arizona and California.

Market Movers

Investors face volatility in reaction to a number of potential market movers during this trading week, shorted by the Memorial Day holiday. In addition to the high drama associated with voting on the debt ceiling resolution, as usual scheduled for after market hours, economic data together with public comments being made on the possibility of additional rate hikes from Federal Reserve officials has upended some futures trading. At this writing, market expectations for the June 14 Federal Open Market Committee policy meeting indicate a 72% chance for another 25 basis point rate hike, one expected to remain in place until November. Key economic data releases including housing, job openings, consumer confidence, the Beige Book regional economic conditions report, and the May jobs numbers on Friday.

Billions, Trillions and Quadrillions

Even with eight arms, it is hard to get them around the concept of a billion, never mind a trillion. Our current budget deficit stands at $925 billion. Our federal debt is at $31.8 trillion and rising. But imagine a million billion or one thousand times a trillion and that is roughly the par value of the securities transactions annually processed by the Depository Trust & Clearing Corporation. DTCC was created in 1973 to help alleviate the increasing volume of paperwork and lack of security stemming from the rapid growth in the volume of trades in the late 1960s. They are a critical market infrastructure provider for the global markets, and in fact processed $2.5 quadrillion of transactions last year. We have worked with DTCC on your behalf for the past 50 years and congratulate them on this milestone anniversary.

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