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BMT Monday Market Insights – April 26, 2021

Top Weekly Themes

  1. Higher bond yields take a breather in April – U.S. Treasury yields moved up relentlessly in 2021 fueled by a reopening of the U.S. economy and high expectations for U.S. economic growth.   The most recent set of economic data has certainly indicated the economic expansion remains on course.   The service sector expanded at its fastest pace since 1997, while manufacturing growth was the fastest since 1983.  Consumer spending increased nearly 10% in March as weekly initial jobless claims dropped below 600,000 for the first time in roughly a year.  Interestingly, the better-than-expected economic data didn’t lead to a further increase in bond yields.  Instead, we saw increased demand (higher prices, lower yields) from different corners of the market, including foreign investors taking advantage of the relative yield advantage in U.S. Treasuries, as well as bond traders covering their short positions.  In our view, intermediate and longer-dated U.S. Treasury yields may have moved too far too fast during the 1st quarter, having rapidly priced in the improvement in economic conditions.  After what we believe will be a relatively brief pause, we continue to think the reopening story will lead yields higher as we move into the second half of the year.  Based on our expectations, the BMT taxable fixed income strategies are positioned with a shorter duration relative to their respective benchmark.
  2. Corporate bond issuance continues to set records – After a record-setting year of corporate supply in 2020, issuers have been active once again in 2021.  In April, the U.S. banking sector was the primary focus, with JPMorgan setting a single US bank issuance record raising $13 billion.  This new high mark lasted roughly 24 hours when Bank of America followed it up with a mega deal of its own at $15 billion.  Goldman Sachs and Morgan Stanley were also in the market adding hefty amounts to their balance sheets.  U.S. banks continue to take advantage of low-interest rates with bank borrowing costs more than 100 basis points below their 10-year average based on data from the Bloomberg Barclays US Corporate Bond Index.  Credit spreads remain near the tighter end of their 10-year average, an indication of strong investor demand and benign borrowing conditions.  We continue to favor corporate issuers over U.S. government bonds, although we recognize the additional yield compensation for credit risk is near the lower end of historical averages.  Given our positive expectations for U.S. economic growth and bank fundamentals this year, we are comfortable with our overweight credit position but are monitoring valuations closely given current credit spreads.
  3. Homebuyers are not deterred by higher and higher lumber costs – the U.S. housing market continues to be a bright spot for the U.S. economy.  Earlier this month, it was reported that March housing starts had risen at an annualized rate of 1.74 million, a level last seen since 2006.  Low mortgage rates and reduced housing supply have contributed to home buyer demand.  What’s interesting is that lumber costs have more than tripled over the past year and have yet to deter home buying.  Increased home prices have absorbed the higher input costs and demand remains strong.  In our view, from a long-term perspective, lumber’s ascent will ultimately reverse, as there are already signs that increased lumber supply will pressure prices even amid persistent housing demand.  For now, with the buying season now upon us, we continue to believe housing activity will remain robust and an overall positive for U.S. economic growth in 2021.

Returns Table

EquitiesWeek (%)YTD (%)1-Year (%)3-Year (%)5-Year (%)Div Yield (%)
S&P 500(0.2)12.450.018.6317.621.35
Russell 1000 Value1.118.055.313.1612.781.85
Russell 1000 Growth(2.4)5.949.423.9722.450.72
Russell 2000(2.3)13.879.514.2216.550.90
MSCI EAFE0.38.246.17.4310.352.27*
MSCI EM (Emerging Markets)(1.7)4.452.88.6113.751.84*
Fixed IncomeWeekYTD1-Year3-Year5-YearDiv Yield
Bloomberg Barclays US Aggregate0.4(2.3)0.65.323.211.49
Bloomberg Barclays US High Yield – Corporate0.22.219.67.107.713.97
Bloomberg Barclays Municipal Bond0.10.67.15.203.471.04
Bloomberg Barclays Global Aggregate x US (Country)(0.0)(3.3)7.93.212.330.92
CommoditiesWeekYTD1-Year3-Year5-YearCurrent Level
Crude Oil WTI (NYM $/bbl) Continuous(0.5)33.4169.7(2.5)7.764.7
Natural Gas (NYM $/mmbtu) Continuous0.615.950.62.66.92.9
Gold NYMEX Near Term ($/ozt)2.7(4.1)7.811.47.01,815.5
Copper Cash Official LME ($/mt)0.429.592.813.915.810,025.5
Currencies1 Week AgoYTD1-Year Ago3-Years Ago5-Years AgoCurrent Level
U.S. Dollar per Euro1.211.221.081.191.141.21
Japanese Yen per U.S. Dollar108.95103.25106.05109.13106.66109.08
U.S. Dollar per British Pounds1.391.371.241.351.441.39
As of May 6, 2021 (close). Three-year and 5-year returns are annualized. *Dividend Yield For MSCI EAFE and MSCI EM are from 4/30/2021.

Chart of the Week

Chart of the Week - 10-yr. U.S. Treasury - Real World
Sources: Bloomberg, Inc., BMT

Takeaways

  • The chart above captures the 10-year real yield (or the yield investors earn after accounting for inflation) since April 1, 2013.  As indicated in the chart, 10-year real yields have been negative since January 2020 reflecting substantial monetary policy easing from the U.S. Federal Reserve (Fed). 
  • Eventually, the Fed will need to take its foot off the gas and alter monetary policy to better align with our expectations of above-average U.S. economic growth.  We believe discussing and adjusting its monthly bond purchases currently running at roughly $120 billion will most likely be the first step.
  • May 2013 was the last time the U.S. Fed prepared investors for scaling back its monthly bond purchases after a long period of increasing its balance sheet.  What is often referred to as the “taper tantrum”, real yields increased more than 100 basis points from March 2013 through December 2013, roughly the same period from when initial Fed tapering discussions began to the reduction of bond purchases that started in January 2014.
  • The takeaway is that real yields adjusted higher well before any actual changes to the Fed’s balance. 
  • We do believe that economic growth expected during the year will lead to Fed discussion, not action, regarding the size of its balance sheet and monthly bond purchases.   However, as in 2013, the market may react to even the consideration of smaller monthly bond purchases.  This could be another force pulling rates higher as we move through the rest of the year.

Commentary

Commentary Chart - 2021-04-26
Sources: Bloomberg, Inc., BMT
  • U.S. employers were actively hiring in March adding over 900,000 to their payrolls, the largest monthly increase since last August.  The unemployment rate dropped to 6.0% while the labor force participation rate inched higher to 61.5%.  All three statistics reflect an improving U.S. labor market.
  • The Fed has projected the federal funds target rate will remain at roughly 0.00% until labor market conditions have reached levels consistent with the Committee’s assessment of maximum employment.   When does improving employment data satisfy the Fed’s maximum employment objective?
  • The above chart focuses on the total number of U.S. employees on nonfarm payrolls.  This past March, there were roughly 144 million on business payrolls compared to roughly 152.5 million in February 2020.  In our view, this gap will need to substantially shrink before the labor market is close to maximum employment. 
  • The 2-year U.S. Treasury yield has traded below 20 basis points (0.20%) for the past nine months indicating investors believe a rate hike remains far off into the future.  We expect the 2-year U.S. Treasury yield will be sensitive to positive developments in U.S. employment and will move higher as employment levels revert to February 2020 levels. 
  • Based on today’s employment levels, we would agree with Fed Chairman’s Powell’s assertion that now is not the time to be “thinking about thinking about raising rates.”  Although employment statistics are moving in the right direction, it’s obvious from the chart that today’s labor market remains a distance away from maximum employment.

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