The question on everyone’s mind right now is, how high will yields go, and “why” are they moving up? We have been discussing several attributes that are creating this pop in yields: supply, Eco numbers, the Fed’s decision for November, and Elections. We will touch on these below.
Visible supply – we have been discussing we have hovered around 17-19B per week; the average is 11-11.50B. Think of a sponge; there is only so much water the sponge can soak up. Right now, that sponge is getting full, but the ACE in the hole is that there is a tremendous amount of money in MM’s, which will be seeking a home.
ECO numbers have been “lackluster,” to say the best. I do not think the FED is convinced they need to move rates in November, and others feel the same way, I think. We have said before that we were surprised by the 50bps move at the last meeting; it feels like they blew the wad on the first trade to us. ECO numbers need to turn (for the worse) in order to regain confidence that the FED will move next month.
FED Decision – similar to the above… there was a time when the street thought 50bps in November, then 25bps, and now it’s questionable if they are going to do anything. When you have these questions, markets don’t like that, and we will continue to see volatility.
Elections – this has always been an issue, and October historically has been volatile for the markets. Many do not think we will see closure with the elections until at least a week after election day…which will create uncertainty. Due to this, there will be opportunistic buys as we move through the next few weeks.
To pile on to the employment data above, after climbing most of the year to a high of 4.30% in July, the US unemployment rate has dropped unexpectedly. One would wonder if this signaled a peak in jobless rates this cycle. Some do not think so, including Bloomberg, as they found three key factors likely responsible for the decline: Brisk Hiring in the education sector, election spending, and responses to natural disasters. Time will tell if we see these numbers change, but one thing is for sure: the FED will be watching this closely.
To add to the visible supply issues, underwriters for MUNIs are forecasting a hectic rest of the year (what is left of it). More importantly, they are predicting a strong 2025 for issuance. BOA indicated they expect around $520B in new issuance for 2025, a record sum while revising their forecast to 460B from 400B.
If you are buying MTA paper, the agency indicated yesterday to investors that principal and interest costs threaten to eat up more of its operating budget unless the state lawmakers find other ways to fund the transit system. MTA has a budget of around $20B each year. Historically, this paper has traded cheaper than most NY paper due to the nature of the underlying asset. I suspect the state of NY, and the city of NY will come to some resolution, but bonds could go lower as they try to “figure this out.”
Deviating from FI, speculate currency traders who swapped between bullish and bearish views on the dollar just made their most significant move three weeks ahead of the elections. Hedge funds and asset managers reduced dollar shorts by $8B in the second week of October. That net positive trading was the largest since the pandemic. The bottom line is that wagers are being placed to bet there will be a stronger dollar in November. We shall see.
Adding FED Talk – a dovish FED, elevated home pricing, narrowing credit spreads, as well as wide-open corporate financing in both the public and private markets, I am sure, is giving the FED second thoughts. As we have been discussing, money flow has not been impeded over the last several months. With all this said, FED Reserve Bank of Dallas president Lorie Logan repeated her call for the US Central Bank to lower rates at a “careful pace” as the economic environment remains uncertain.
We spoke about certain municipalities in NC and TN early this week, following the hurricane, and how, sadly, the destruction caused could cause certain municipalities to be downgraded. S&P reported on 10/17 that they have placed 12 municipalities on credit watch with negative implications, all of which currently have investment-grade ratings.
The Bottom Line:
Yields are up +25 across the curve, and we think they have room to climb slightly higher. If you are buying quality paper and in this for the long haul, we continue to indicate to buy on these dips. It is hard to say how high yields will increase, but overall, municipalities are in good shape, and your income from the accounts will not be impacted if you own quality paper. I suspect we will see +5-10 from here across the curve, issuance will need to slow down, elections will need to pass, and the Eco Numbers will need to “slow down” to regain confidence the FED will cut. With all of this said, from a “30,000 ft view,” I do, along with others, expect the FED to cut over the next 12 months; therefore, again, if you are buying for the long haul, it is a good time to be in the markets.
At The DRL Group, we specialize in helping high-net-worth investors maximize tax-free returns by proactively maintaining their custom bond portfolios through all market conditions.
David Loesch
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www.drlgroup.net
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Do not buy discount bonds based on the Yield-to-Call (YTC). YTC does not indicate total return; this yield is valid only if the security is called. Bonds may be callable on multiple dates or any date following the first call date, so yield to call is based on the earliest stated call date. Discounted bonds may be subject to capital gains tax. Bonds may be subject to OID (Original Issue Discount). Bonds could also be subject to the DeMinimis Rule; please consult your tax advisor for further clarification. Insured bonds are issued for timely principal and interest payment only, do not cover potential market loss, and are subject to the insurance company’s claims-paying ability. Municipal income may be subject to state, local, and Alternative Minimum Tax (AMT) taxation. Corporate and Municipal securities are subject to gains/losses based on the level of interest rates, market conditions, and credit quality of the issuer. Non-rated (NR), With-Drawn (WR), or below investment grade bonds, lower-rated bonds carry a greater potential risk of default & should be considered by sophisticated investors only.
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