Market Commentary: Semi-Sweet

by Gayl Mileszko


Sweet tooths around the world are aghast at the soaring prices of their favorite chocolate treats.  Raw sugar futures contract prices have been climbing since the start of the pandemic and, at $25.45 a pound, are now at an 11-year high. Cocoa prices at $3,193 per metric ton at this writing are up about 14% this year. Unusually hot and dry conditions have produced disappointing harvests in west Africa, where the Ivory Coast and Ghana produce 60% of the world’s supply. The return of El Nino as well as rising raw material costs, higher energy expenses, and rising interest rates are other factors adversely impacting prices for chocoholics. The average American consumers 10 pounds of chocolate a year, and sales are expected to hit a record high $52.9 billion this year.

Research May Drive Healthier Choices

Chocolate is made with the seeds of the cocoa trees which are fermented, cleaned, roasted, winnowed, ground, and turned into a liquor that features more than 300 chemical compounds that contribute to its addictive quality. The liquor is sweetened with sugar, blended and tempered. Scientists from the University of Leeds set out to discover why it makes us crave that irresistibly tasty, melt-in-the-mouth feeling. They built a 3-D printed tongue to aid in their investigation of texture sensation and learned that chocolate releases an outer of fatty film that coats the tongue, giving a smooth feeling that is followed by the delicious cocoa and sugar combination. They believe that their research can be applied to help design healthier versions of ice cream and cheese as well as chocolate.

Federal Reserve Choices

The Chair of the Federal Reserve was widely expected to deliver the sweet news of a pause, or skip, in the record-setting 10-meeting rate hike program that has ground some debt issuance to a halt, tempered consumer spending, and helped to winnow last June’s 9.1% inflation down to 4.0%. But the latest consumer price index data for May showed that the drop was in large part due to a 3.6% decrease in energy prices, offsetting in part the increases in housing, used vehicles, transportation and food. Consumers, besieged by high mortgage, credit card, and car loan rates as well as elevated grocery prices are turning their wrath to retailers exhibiting “greedflation” —  raising prices to bolster margins amid solid supply chains and declining production costs — and “shrinkflation” —  jacking up prices while reducing the size of their products. The Federal Open Market Committee considered both CPI and the producer price index, which fell to 1.1% year over year, or 2.8% when excluding food and energy, in its June 14 rate decision, and kept alive the possibility of additional rate increases in the months ahead. Markets, which crave that elusive factor of certainty, move forward without real clarity.

Treasury Borrowing To Total $1 Trillion in 2023

Money is growing on proverbial trees at the U.S. Treasury. This week there are 10 auctions for $195 billion of bills, notes and bonds to replenish coffers that were emptied during the debt ceiling debate. Cash balances are expected to increase to $425 billion by the end of this month, and $600 billion by the end of the fiscal year. Total sales are expected to amount to $1 trillion by the end of December. Some analysts are concerned that the markets will be unable to absorb this level of supply, while others point to the gush of inflows into money market funds, where assets have risen to an all-time high of $5.45 trillion and appear to be still climbing. Some Fed-watchers were certain that the FOMC would pause so as to monitor market acceptance of this huge influx, expecting yields to climb another 10 to 20 basis points, almost the equivalent of another Fed rate hike.

Tax-Exempt Pipeline Builds

In the tax-exempt market, issuance has remained fairly light with quite a few borrowers remaining on the sidelines awaiting some semblance of stability in rates. But many economic indicators are holding firm and the Fed is likely near if not at its tightening peak. State and local governments as well as corporations and non-profits are in need of capital and some cannot postpone market entry. In the muni market, all 3% coupons are trading at discounts and new issue demand is for 5% coupons. For high yield buyers, we note that four non-rated charter or private schools in Arizona, California, Idaho and Texas came to market last week; a 9-year term bond priced at par to yield 7.50%, a 30-year maturity priced with a coupon of 6.25% to yield 6.40%, a 35-year maturity priced at 6.375% to yield 6.325%, and a 40 year maturity priced at 6.375% to yield 6.50%. Due to the inversion of the municipal yield curve, a highly unusual condition prevailing since early December, many deals are being priced with 1-year and 2-year yields higher than 10-year and 12-year maturities. The Municipal Securities Rulemaking Board reports that total issuance during the first five months of the year is $148.6 billion, 16% or $29.5 billion below the same period last year. About 12% of primary market bond sales are of taxable munis and 24% are refundings. Only $3 billion of sales are scheduled for this week, and the 30-day forward calendar presently totals $7.1 billion.

Mutual Fund Inflows for the First Time in 16 Weeks

The level of municipal bond bids-wanted and offerings remains elevated; some of this is due to the bank sales directed by the Federal Deposit Insurance Company. The market is taking all this in stride, with no obvious pressure on the overall market. Investors returned to mutual funds for the first time in 16 weeks, adding a net of $592 million to conventional muni bond funds, $380 million of which went into high yield funds. Muni investors have received in $30.2 billion of principal and interest already this month and are expected to receive another $21.7 billion by the end of the month. Trading this month reflects that investors are net buyers. ICE BofAML index year-to-date returns as of June 9 show that investment grade municipals are up 2.36%, nonrated munis +3.58%, taxable munis +4.47%.

Growing Retail Demand for Municipals

The Federal Reserve System Board of Governors released its quarterly report on financial accounts of the United States last week. It tallies the market value of the municipal bond market at $4.01 trillion with the majority of muni securities $1.66 trillion held by households, an increase of 3.7% from December and 9% from the first quarter of 2022. The report also showed that bank holdings declined by 2.3% year over year while foreign holdings were up 6.9%. Municipal Market Advisors analysts have been pointing out the key role that individual buyers have held all year long in supporting the muni market as yields have risen. However, they have noted that the peak summer vacation period running from June 16 to August 21 has seen retail trading decline by an average of 11% since 2009 while institutional trading declines by 22%. At HJ Sims, our retail and institutional trading desks are active all summer long in support of the primary and secondary markets. Our clients, none of which we categorize as average, are expected to remain equally active.

Current Markets

At this writing, the SIFMA 7-day municipal swap index stands at 2.84%. The 1-year AAA municipal general obligation bond yield is 3.07%, the 2-year is at 2.95%, the 10-year stands at 2.59% and the 30-year at 3.50%. The 10-year BAA corporate bond benchmark yield is 6.28%. The peak of the Treasury yield curve is the 6-month bill at 5.33%. The 2-year stands at 4.61%, the 10-year at 3.78% and the 30-year at 3.89%. In anticipation of the FOMC decision, the MOVE Index measuring bond market volatility at 118.80 is well below the 12-month average at 130.23. The Dow at 34,131 is up 3.7% this month, the S&P 500 at 4,387 has gained 5% and the Nasdaq at 13,634 is up 5.4%. Oil at $68.74 a barrel is higher by 1% while gold at $1,955 an ounce is down a 0.5%, and Bitcoin at $25,949 is off by 3.7%.

We welcome your contact with our HJ Sims representatives for updates on market conditions, reviews of your portfolios and capital and income needs. As with the chocolate we all enjoy, our guidance all begins with a seed, the seed of fundamental analysis. It is tempered by our 88 years of experience, and textured with the partnership we have in your success.

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