HJ Sims Market Commentary: The Seventeenth Chair

by Gayl Mileszko

The Senate Banking, Housing and Urban Affairs Committee holds its hearings in Room 106 of the Dirksen Senate Office Building, the second of three Senate support offices constructed in 1958 to accommodate a growing number of committees and staff. The imposing structure was later modified to provide space for individual senators and their personal staffs. In 1972 it was finally given a name, one in honor of the great orator, Everett M. Dirksen, a Republican of Illinois who served as a member of the House and Senate for 36 years. It is now home to 18 senators and 10 committees including the one with jurisdiction over matters related to everything from banks and deposit insurance to currency and coinage, price controls, export promotion, public and private housing, urban development, and federal monetary policy. The Banking Committee has a history dating back to March of 1913 when it was created to consider the Federal Reserve Act. Debate in the upper chamber was as contentious back then as it was today; in fact, the Committee deadlocked 6 to 6 in its first vote on the bill to create a central bank. The Senate eventually agreed to a compromise with the House and the Federal Reserve Act was signed into law on December 23, 1913. Just over 108 years later, the Committee held re-nomination hearings for Jerome Powell, the seventeenth Fed chairman.

After Inflation and Pandemic, a Double Whammy

At Tuesday’s hearings, the nominee fielded hours of questions from the Committee’s 24 members in an open and hybrid session. He reassured senators, Wall Street and Main Street that the Fed will be applying its full array of tools to tackle the inflation that is at a four decade high during a pandemic and still plaguing the nation after nine straight months. Those responsible for monetary policy plan to do this by raising rates as necessary while the economy continues to rebound. But they are also signaling that a reduction in the central bank’s $8.7 billion balance sheet will occur fairly quickly after the rate hikes begin. The double whammy is not exactly surprising, but it has sure shaken the eggnog out of the last few holiday revelers and everyone who has been dizzied by the central bank’s novel intoxicants. Zero rates, forward guidance, credit easing and asset purchase programs were introduced during the Great Recession and more powerful spirits in the form of lending, funding and liquidity facilities, new repurchase operations, and international swap lines, and relaxed regulatory requirements were added during the pandemic.

Market Volatility Up 12 Percent

Bond yields suddenly surged last week on the sobering prospect of three or maybe four rate hikes in the next 12 months accompanied by a reduction in Fed holdings of Treasuries and mortgages. Investors reliant upon the Fed to continue buoying stock prices began to picture a whole different seating arrangement, one on a stage with higher borrowing costs, less liquidity and fewer safeguards. On top of that, the Labor Department released very weak payroll numbers for December and a surge in Omicron cases produced a new round of school closures and work-from-home policies. Market volatility as measured by the VIX is up more than 12% this year. Major equity indices have all lost ground: at this writing, the Nasdaq is down almost 5 percent, the Russell 2000 is off by more than 3 percent, the S&P 500 by 2 percent and the Dow by almost one percent. Concerns are growing that the Fed will overreact and have to reverse course to avoid another recession. But amid all the negative headlines, the economy is still in a strong recovery mode. Traders will nevertheless closely watch the inflation data out this week and the trajectory of two- and ten-year Treasury yields: any sign of an inverted yield curve, one in which the shorter maturities trade at higher yields than the longer ones, is an historically reliable leading indicator of a recession within 12 months. The Fed, which tracks the curve on a daily basis, shows that the difference has been narrowing since October 20.

Bond Yields Inching Back Up to Pre-Pandemic Levels

As of Monday’s close, the 2-year Treasury yield at 0.89% is up 16 basis points on the year. The 10-year at 1.76% is 25 basis points higher, back to just about where it stood in late January of 2020. The 30-year at 2.08% has risen 18 basis points. The BBB corporate index effective yield at 2.82% is still below 2.93% where it stood 2 years ago. Tax-exempt muni benchmarks have lagged Treasuries, happily swirling in the same favorable technical conditions that have prevailed throughout 2021: heavy demand fueled by expectations for higher taxes, insufficient supply despite $500 billion of issuance, reduced availability of tax-exempt offerings given the increase in taxable refundings and allure of hungry corporate markets, and record levels of investment in municipal bond funds and exchange traded funds. It was inevitable that munis would eventually react to the government bond market’s move to higher yields, and so muni benchmarks all rose last week for the first time since December 9.

Municipal Bond Market Conditions

At this writing, the 2-year AAA general obligation bond benchmark yield at 0.46% is up 22 basis points in the new year. The 10- and 30-year yields have risen 16 basis points to 1.19% and 1.65%, respectively. But these levels are all still well below where they were two years ago when the 2-year was at 0.96%, the 10-year at 1.35% and the 30-year at 1.98%. Ten years ago, the 2-year stood at 0.37%, the 10-year at 1.79% and the 30-year at 3.33%. So borrowers still have extremely favorable access to capital and bondbuyers still have quite a way to go to reach the average for the past 20 years. Any signs of change are incremental and, on top of inflation data, investors will be closely following reaction to the weekly fund flow reports out on Thursday. Some analysts are predicting an outflow cycle to begin after this most recent string of 44 weeks, but income investors who shudder at the volatility of stock, crypto and commodity markets and feel the hit that inflation is taking every week, have few places aside from high yield muni and corporate funds to place their cash. And they have a lot of cash to re-invest: muni bondholders are taking in $34 billion of principal and interest payments this month alone, and will see more than $439 billion by the end of the year.

In the Market This Week

As is typical in the wake of the holidays, the municipal calendar so far this year has been light and dominated by highly rated financings. The first senior living deal we note came for Kendal at Ithaca in two issues rated BBB+ totaling $11.5 million; the 2.16% maximum yield bonds are due in 2042. This week’s slate totals $8.6 billion and includes an $862 million BB+ rated deal from the Chicago Board of Education which has been in the spotlight of late due to its decision to close schools for the last 5 days. We also note five ESG issues, two forward settlement and two corporate CUSIP college deals. The investment grade corporate bond calendar is estimated at $30 billion this week, and high yield corporate offerings are expected to total $30 billion by the end of the month. Earnings season kicks off this week with fourth quarter reports from most of the major banks in addition to Delta Airlines and Albertsons, the nation’s second largest supermarket chain.

Change is in the air once again this new year. Given the 36 House and Senate retirements already announced and mid-terms on the horizon, committee chairs will be re-shuffled on Capital Hill. Many on Wall Street and Main Street are being rousted from their easy chairs. Our HJ Sims representatives are here working hard to ensure your place at the table. We welcome your call to learn of our current offerings, help refine your strategies for the year, review your portfolio, and present some investment and financing options that you may not have considered. HJ Sims has guided our clients through every market cycle since 1935 and we are here for you in 2022.

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