by Gayl Mileszko
All great leaders are defined by how they lead during times of uncertainty and danger. Right now, in the midst of great uncertainty over whether our leadership will come to agreement on a new debt limit and spending priorities and when, we are mostly going easy on our elected officials. There are few cries for impeachment, no major civil unrest and no major recall elections underway despite high inflation, high interest rates, sky-high federal and household debt, rampant crime and our grim outlook for the economy. We are likely heading into a recession. We are at war against terrorism and incurring new debt to support Ukraine in its battle against Russia. We have been admitting and financing millions of undocumented men, women and children from more than 160 countries coming across our southern border. There is plenty of blame to go around for this current sea of troubles, but most Americans believe that our leaders will do the right thing to address our most pressing problem – the debt ceiling.
Long List of Problems to Resolve
Our problems are large and often appear unsolvable given divided government and all the political acrimony. We badly need new immigration laws, more deflationary measures, deficit reduction, reforms in our insurance and benefit programs, lower interest rates and policies promoting economic growth. There is almost nothing that we can do as individuals to fix these and other problems, but we place our faith in the institutions and those elected or appointed to lead them. This is especially true when the world is watching, as it does every few years, to see how committed we are to paying our bills, the interest and principal on the $31.4 trillion of debt we have already incurred. Last year, interest payments alone totaled $475 billion. This year they are estimated to total $663 billion. They are projected to reach $1.4 trillion in Fiscal Year 2033.
Pressure from Every Corner to Produce Agreement This Week
There is a lot of pressure on Members of Congress and Administration officials to avoid any possibility of a payment default. Markets understand the difference between an inability or unwillingness to pay (as has been seen in the cases of Greece, Mexico, Brazil, and Venezuela) and a temporary political standoff. But estimates from the Treasury and Congressional Budget Office indicate that we are running out time. An agreement in principle is needed and will likely arrive this week. The limit has been managed these past 5 months with a number of accounting measures and previously relied upon gimmicks to give those on Capitol Hill and in the White House time to raise or suspend it. The fact that it has not yet been done will be a topic for discussion at the G-7 meeting in Hiroshima, Japan this week. It is the subject of hot line calls from Wall Street titans having to pay up to hedge against a potential default, and voters who rely upon regular federal benefit payments. It is the hot topic at each of the 10 Treasury auctions being held this week. The staffs of the principals in the negotiations have been working to come up with acceptable terms but it always comes down to the wire, typically after an ugly stretch in the financial markets threatening the investment portfolios of all those in Washington, and urgent messages from heads of state. Foreign countries hold about $7.4 trillion of our debt, including Japan ($1.1 trillion), China ($859 billion), the United Kingdom ($668 billion) and Belgium ($331 billion).
Leadership Addressing the Debt Limit
The staff negotiators in the high stakes talks may have what Mike Rowe might call the “dirtiest job”, certainly among the most thankless. The outcome, avoiding a default by revising the limit, is expected by everyone, and anything beyond that is perceived by everyone outside of the Beltway as minor details, most likely to be changed by the next Congress. But the principals who need consensus must deal with vicious opposition within their own party whether that relates to the debt limit itself or any number of the related provisions of the joint resolution. There is also relentless pressure from the 24/7 media, constituents, major banks, and lobbyists for interests ranging from AARP to the mohair industry to the Bond Dealers of America. The closer the talks get to X-Date, of course, the better the fundraising opportunities, but in the end this is all about paying past due bills and not new pork barrel project spending. For this and all the other consequential crises faced by these leaders, the pay is not all that great in the context of the private sector, where Jamie Dimon was just paid $34.5 million, and the median pay package for S&P 500 CEOs last year was $14.5 million. No one battles to hold high office for monthly paycheck, but the 46th President of the Unites States is paid $400,000. The 78th Secretary of the Treasury receives $219,200. The 55th Speaker of the House gets $235,100. The 25th Senate majority leader is paid $193,400. The 16th Chair of the Federal Reserve receives $190,000.
Veteran Traders Place the Debt Ceiling Crisis in Historical and Current Context
Since Treasury Secretary Janet Yellen’s letter to Congress on January 13 reporting that the U.S. has reached its debt limit, and that “extraordinary measures” were in place to continue paying the government’s bills, the markets mostly placed the debt ceiling issue on a back burner. Old guard traders who have been through this before saw a 6 or month horizon before the real sparks began to fly. They focused first on the economic data driving the Fed’s next rate actions, and then on the risk of contagion in the banking sector. But with the passage of time, the belief that rates go down from here, the major bank fails behind us, and intense media attention to the prospect of default given the lack of progress in negotiations, they began running what-if scenarios and setting up hedges as well as fallback operational plans. There have been an average of 8 Treasury auctions a week this year and regular sanity checks between Treasury and the primary dealers, given the potentially devastating impacts that a missed debt service payment would have on them, their inventory, clients, contracts, and collateral.
Bond market volatility peaked on March 15 with the MOVE Index at 198.71 and currently stands at 120.52, slightly below average for the year reflecting confidence that leaders in Washington will soon come to an agreement. Stock market volatility, as measured by the VIX, saw its high on March 13 at 26.52 and currently stands at 17.03, also below the average for 2023. In 2011, the VIX reached a high of 48 on August 8 right after the S&P downgrade of America’s credit rating to AA+. Recalling with clarity this as well as the series of events that transpired 12 years before when she was Vice Chair of the Fed, Secretary Yellen saw April tax receipts came in below expectations and promptly advised the Congress on May 1 that the Department would be unable to satisfy all of the government’s obligations by early June, potentially as early as June 1. Bond market volatility has since dropped by 1.6% while the VIX has risen by 8%. During the first two weeks of May, the Dow at 33,399 has lost 2.3%, the S&P500 at 4,124 is down 1.1%, the Russell at 1,740 has fallen 1.6% while the Nasdaq rallying on tech earnings at 12,284 is up 0.5%.
The Bond Markets
Since the May 1 warning, the 2-year Treasury has fallen 2 basis points to 3.98%. The 10-year yield is 4 basis points higher at 3.46%, and the 30-year benchmark at 3.78% is up 11 basis points. The Treasury curve has been inverted since last July 5 and it peaks with the 1-month bill yielding 5.41%. Returns in the ICE BofML Treasury Index are down 0.14%. The 10-year BBB corporate bond yield stands at 6.00%, flat on the month but high grade returns are down 0.64% and high yield bonds have lost 0.44%. Taxable municipal bonds also have negative returns this month, with the index lower by 0.51%. But the highest rated tax-exempt municipal general obligation bonds have followed their own path this month in response to a larger primary market calendar, inflows into muni ETFs, high yield and national funds, successful Blackrock efforts to slowly sell off various failed bank holdings, and reinvestment opportunities accompanying the $38.1 billion of principal and interest being paid to bondholders in May. The 2-year AAA benchmark at 2.69% is flat on the month. The 10-year at 2.31% is down 4 basis points and the 30-year benchmark yield at 3.36% is 3 basis points lower. Investment grade munis are returning 0.34% this month, high yield munis are 0.35% higher and non-rated munis are up 0.43%.
Last week, HJ Sims brought a $14.1 million AAA rated charter school bond financings for Orenda Education through the Newark Higher Education Finance Corporation. The transaction was guaranteed by the Texas Permanent School Fund and was structured with six term bonds. The final maturity in 2058 was priced at a discount with a 4.25% coupon to yield 4.50%. The Arlington Higher Education Finance Corporation issued $24.5 million of triple-A rated bonds with the PSF guarantee for UME Preparatory Academy that came with a maximum yield of 4.35% in thirty years. In the high yield sector, the Cuyuna Range Hospital District sold $25.8 million of non-rated health care facilities revenue bonds that included 2053 term bonds priced at par to yield 5.75%. The Colorado Educational and Cultural Facilities Authority brought a $6.4 million non-rated charter school financing for Mountain Phoenix Community School that featured a 30-year maturity priced at par to yield 6.25%. In the senior living sector, which has been extremely quiet so far this year, the Wisconsin Public Finance Authority private placed $23 million of non-rated bonds at par to yield 6.875% for Village Point and Springpoint at half Acre Road in Monroe Township, New Jersey.
Market Movers This Week
Psychologists, Washington insiders, and artificial intelligence experts are in great demand these days on Wall Street, helping to gauge risk and opportunity for traders. Market participants are digesting the latest retail sales and housing data, Friday’s revised CBO deficit and debt projections, and monitoring the $30 trillion credit default swap market for U.S. credit default swap spreads which hit a near-record high last Wednesday. Investors are tuned into news from the G-7 summit and plans for the Turkish election runoff. Many watch the congressional hearings on artificial intelligence, with some positing that AI could be the largest investment trend ever. The corporate bond market is absorbing the seven Chapter 11 filings made on Sunday while following key retail earnings releases and witnessing the fourth largest sale on record as Pfizer comes with a $31 billion, 8-part deal that saw a reported $85 billion in orders. There are 9 Treasury auctions scheduled and 15 Fed officials on the speaking circuit.
At HJ Sims We Love Our Job
Those in our nation’s capital may rue their career choices in times like this but your HJ Sims representative welcomes your call this week as events unfold on the domestic and international fronts. We are hard at work also — advising our senior housing, hospital, and charter school clients on market opportunities, and assisting our brokerage and advisory clients with current credit and value opportunities. Rates are historically attractive for borrowers. Yields are most alluring for buyers, particularly on the short end for those looking to put cash to work: the 7-day SIFMA municipal index is at 3.04% , the 1-year AAA tax-exempt municipal yield is over 3.00%, and the 6-month Treasury is yielding 5.27%. Talks in DC may not always produce a good outcome from hour-to-hour or day-to-day, but we find that regular conversations with you on your income needs and goals are invaluable.
For more information on offerings or questions about current market conditions, please contact your HJ Sims representative.