Market Commentary: Rhymes

by Gayl Mileszko

History doesn’t always repeat itself but, as Mark Twain reportedly once said, it often rhymes. Looking across the investment landscape, we find ourselves facing events and conditions that have been experienced before but are hardly worthy subjects for song or poetry: a debt limit standoff reminiscent of 2011 and 2013, interest rates not experienced in 16 years, inflation rates not seen in 40 years, levels of U.S. debt as a percentage of GDP that now exceed the 1945 peak, a 100-year pandemic, the 25th instance in 123 years of divided party control in Washington, a 1,000-year rainfall, and now a possible repeat of the 2020 presidential contest. The financial markets take these developments and others into account every day and struggle for direction.

Sing a Song of Sixpence

The artificially low caps on rates that became the norm for nearly 15 years were yanked off last year and there has been an aggressive series of nine rate hikes by the Federal Reserve, which has skewed short- and long-term bond yields since last July 5 and introduced new volatility to the stock market. But the Nasdaq, at the time of this writing, is up 15.64% year-to-date, the S&P 500 is up 8.20% and the Dow is 2.65% higher. The height of the U.S. Treasury curve, the highest yielding government bond, at the time of this writing, is now the 3-month bill at 5.11%. This reflects market expectations for another 25 basis point increase on May 3 and a pause in this range of 5.00% to 5.25% until September, when some easing is projected to begin anew. We have not seen the 3-month so high since February of 2007 or January of 2001. We have not even seen the 10-year or 30-year yields that high since July of 2007. The highest short-term yields in more than a decade have driven investors to money market funds, where assets at $5.2 trillion are up 17% in the past year.

Pop Goes the Weasel

At the time of this writing, the spread between the 1-month and 3-month is at the highest on record. Credit default swaps on the U.S. are the most expensive they have been with the 5-year CDS at 50 basis points. Since the first Fed rate hike on March 17, 2022, the 3-month yield has surged 510 basis points. The 2-year Treasury yield has risen 217 basis points to 4.08%, the 10-year is up 132 basis points to 3.49%, the 30-year is 124 basis points higher at 3.70%, and the 10-year Baa rated corporate bond yield has increased 158 basis points to 6.03%. After suffering losses of 12.86% in 2022, Treasury indices are up 2.72% so far in 2023. Investment grade corporates which had returns of negative 15.45% last year are 3.43% higher this year. High yield corporate bonds are returning 4.18% in 2023 after losing 11.22% last year. Alongside this year’s rate increases — which have impacted all sovereign, corporate and asset-backed prices for bondbuyers — Main Street has also been significantly affected. In an effort to stifle consumer demand and bring down inflation, the Fed has caused 30-year mortgage rates to jump from 4.16% to 6.39% and credit card interest rates to rise from 16.34% to 20.22%.

The Wheels on the Bus

In the tax-exempt world, the Fed’s monetary policy has increased yields, suppressed issuance, produced months of negative returns, and spurred record mutual fund outflows. The 2-year AAA general obligation bond yield at 2.56% has increased 117 basis points since that first Fed rate increase, the 10-year yield is 43 basis points higher at 2.36%, and the 30-year benchmark yield at 3.40% is up 107 basis points. Muni bondbuyers nevertheless continue to demonstrate strong demand for tax-exempts. This year, long-term muni funds have taken in $1.04 billion of net inflows and high yield muni funds have seen $1.58 billion of net new money. Taxable muni index returns are up 5.08% year-to-date, non-rated munis are up 2.74% and investment grade munis have returned 2.38%. Issuance has picked up in the past few weeks as borrowers see light at the end of the tunnel. Futures traders see Fed target rates dropping to 4.25% by year-end and to 3.00% by December 2024.

Jack and Jill Went Up the Hill

This is the first time in 2023 that we have seen back-to-back new issue muni calendars exceeding $8 billion and we encourage borrowers to take advantage of conditions that remain favorable. Last week, we saw another slate dominated by high grade sales. But we saw good activity in the high yield space. The Indiana Housing and Community Development Authority sold $23.2 million of non-rated bonds for Vita of Greenfield which featured 2043 term bonds priced at par to yield 6.875%. The South Carolina Jobs-Economic Development Authority had a $9.9 million non-rated educational facilities revenue bond issue for Libertas Boiling Springs that had a single 2030 maturity priced at 7.50% to yield 8.265%. The Port of Greater Cincinnati Development Authority brought a $53.2 million non-rated taxable convention center refunding deal due in 2025 that priced at par to yield 5.00%. The La Paz County Industrial Development Authority sold $31 million of non-rated bonds for the Florida Charter Educational Foundation due in 2030 and priced with a coupon of 6% to yield 6.125%. The Arlington Higher Education Finance Corporation in Texas had a $19 million Ba2 rated revenue bond issue for Basis Texas Charter Schools structured with 2056 term bonds priced at par to yield 4.875%. And the California School Finance Authority issued $11.1 million of BBB-minus rated sustainability bonds for Camino Nuevo Charter Academy that came with a 2053 maturity priced at 5.25% to yield 5.32%. This week’s calendar includes plans for an $11 million BBB-minus sale for STEM Prep in California and a $26.1 million Texas PSF-guaranteed deal for Great Hearts Academies.

If You’re Happy and You Know It

With the April tax filing now behind most investors, we welcome a renewed focus on tax-advantaged investments. All eyes are on quarterly earnings and outlooks being reported by banks and other major buyers of bonds this week. For S&P 500 companies, it is the most active week of the quarter. In Washington, Congress continue to wrangle with debt limit issues and we see that the cost of insuring against a default has become more expensive. Traders are closely following the 9 Treasury auctions scheduled and awaiting news from the Secretary on when extraordinary measures have been exhausted and progress on the U.S. House measure linking a temporary increase to spending reductions. Analysts will closely watch muni fund flows, which saw $2.2 billion of net asset losses last week, and how investors are planning to reinvest the $20.6 billion of principal and interest hitting accounts on May 1.

At HJ Sims, we stand by ready to review your strategy for the second quarter of the year in the context of your capital needs, investment goals and risk tolerance. We are finding good value in bids-wanted and offerings for higher yielding bonds as we surveil individual credits and key sectors. Reach out to your HJ Sims representative where we work with you to find strategies that rhyme with income.

For more information on offerings or questions about current market conditions, please contact your HJ Sims representative.

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