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BMT Monday Market Insights – June 14, 2021

Top Weekly Themes

  1. U.S. debt market not shaken by corporate bond sales – Last week, the Federal Reserve (Fed) began unloading its corporate bond holdings that were scooped up through the Secondary Market Corporate Credit Facility (SMCCF), an emergency facility established last year to support the flow of credit during the pandemic. The SMCCF is independent of the Fed’s ongoing roughly $120 billion monthly bond purchases. The Facility was hugely successful in bringing stability to the credit markets and lowering corporate borrowing costs. Bond purchases included both investment grade and high yield debt, the latter drawing much public critique given the embedded credit risk. Interestingly, the facility is expected to generate a profit for the U.S. Treasury. Liquidations thus far have been well received by market participants. Going forward, we expect ongoing sales from the roughly $14 billion corporate debt portfolio will continue to be a sideshow for investors with little impact on credit spreads. The portfolio is simply too small, with sales expected to gradually occur throughout the year. Any notable credit spread widening we would view as a potential buying opportunity.
  2. Within shouting distance of 0.00% – The 10-year German Bund yield was within roughly 11 basis points (0.11%) of offering a positive yield to investors last month before retreating to -0.25% on June 9. The security hasn’t crossed the 0.00% mark in a little over two years. The European Central Bank recently stepped up its monthly bond purchases via the 1.85 trillion-euro Pandemic Emergency Purchasing Program to better align policy with economic conditions that were adversely impacted by high levels of COVID-19 cases. Inflation in the euro area increased to 2.0% in May but not enough to spark long-term inflationary concerns. Looking forward, we believe a rise in the German Bund 10-year yield will likely reassert itself as vaccinations become more widespread, lockdown restrictions ease, and the eurozone economy reopens.
  3. Is it time to begin the tapering bond discussions? – The Fed meets this week, and markets will undoubtedly be listening for any insight regarding the future course of quantitative easing. We believe tapering discussions are certainly possible given the amount of recent Fed commentary on the topic but expect changes to monthly purchases wouldn’t begin until later this year or early 2022. In our view, Fed conditions related to maximum employment and price stability goals have yet to occur. Regardless of the start date, we recognize the Fed’s ongoing monthly demand for U.S. agency mortgage-backed securities (MBS) has already had an influence on valuations. The MBS option-adjusted spread, the yield compensation above U.S. Treasury securities for prepayment risk, declined from 80 basis points (0.80%) on May 31, 2020, to 16 basis points (0.16%) on May 31, 2021, based on data from the Bloomberg Barclays U.S. Agency Fixed Rate MBS Index. Tapering discussions have been and will continue to be a hot topic this year. Regardless of the eventual liftoff, anticipating that a big buyer of MBS will eventually be stepping back from the sector contributed to our decision to lighten up on our MBS exposure considering current valuations. In the BMT Core Fixed Income Strategy, we modestly reduced our MBS allocation in favor of short-term investment-grade corporate bonds.

Returns Table

EquitiesWeek(%)YTD(%)1-Year(%)3-Year(%)5-Year(%)Div Yield(%)
S&P 500(0.7)20.533.717.6518.051.28
Russell 1000 Value(0.6)18.835.610.8311.721.87
Russell 1000 Growth(0.8)20.434.124.3824.360.66
Russell 2000(0.6)13.946.710.5114.220.91
MSCI EAFE(0.3)12.827.210.1910.522.43*
MSCI EM (Emerging Markets)(1.8)1.618.510.6510.562.07*
Fixed IncomeWeekYTD1-Year3-Year5-YearDiv Yield
Bloomberg Barclays US Aggregate0.4(0.4)0.05.723.291.42
Bloomberg Barclays US High Yield – Corporate0.35.010.97.176.863.75
Bloomberg Barclays Municipal Bond0.11.63.45.263.450.96
Bloomberg Barclays Global Aggregate x US (Country)0.4(3.1)1.04.102.100.85
CommoditiesWeekYTD1-Year3-Year5-YearCurrent Level
Crude Oil WTI (NYM $/bbl) Continuous4.849.689.71.710.672.6
Natural Gas (NYM $/mmbtu) Continuous11.1116.2131.225.413.35.5
Gold NYMEX Near Term ($/ozt)0.1(5.3)(8.4)14.56.41,792.4
Copper Cash Official LME ($/mt)2.522.639.316.915.09,488.5
Currencies1 Week AgoYTD1-Year Ago3-Years Ago5-Years AgoCurrent Level
U.S. Dollar per Euro1.181.221.191.171.121.18
Japanese Yen per U.S. Dollar110.34103.25105.48112.10102.40109.30
U.S. Dollar per British Pounds1.371.371.291.311.321.38
As of 9/15/21 (close). Three-year and 5-year returns are annualized. *Dividend Yield For MSCI EAFE and MSCI EM are from 8/31/2021.

Chart of the Week

Chart of the Week
Sources: Bloomberg, Inc.; BMT

Takeaways

  • U.S. job openings were plentiful in April, hitting a record high of over 9.2 million. A positive considering the unemployment rate remains elevated at 5.8%, with roughly 7.6 million fewer workers today compared to February 2020. We believe the labor market is well-positioned to improve as the year progresses, given the obvious demand for workers combined with the likelihood that certain factors limiting job seekers’ ability/interests to enter the workforce will ease.
  • First, the enhanced job benefits that may have kept individuals on the sidelines are expected to retire in September. At least 20 states have already decided to cut them off sooner. Second, hesitation in returning to work for health reasons will likely ease as vaccinations continue and individuals gain more confidence resorting back to pre-pandemic lifestyles. And third, those caring for young ones during remote school learning will certainly get some support when schools reopen in the fall.
  • Job openings are an obvious necessity for continued improvement in the labor market. Just as important are fewer barriers holding individuals back from the working environment. The factors noted above have presented pandemic-related “bottlenecks” within the labor market that are expected to ease as the year progresses. As they subside, we believe there will be better alignment between job openings and job seekers and position the U.S. labor market for continued improvement within a hopeful post-pandemic U.S. economy.

Commentary

Commentary Chart
Sources: Bloomberg, Inc.; BMT
  • Short-term interest rates continue to trade near 0.00% as funding markets are filled with cash. The Fed’s ongoing quantitative easing program coupled with the U.S. Treasury paying down its General Account are the primary culprits. Both inject additional dollars into the funding markets searching for a home.
  • Short-term Treasury bills have been trading with negative yields while the U.S. effective federal funds rate (EFFR) has inched its way to 6 basis points (0.06%) this year. Banks utilize the federal funds market to borrow/lend reserves to each other.
  • The Fed is currently targeting an EFFR in the range of 0.00% to 0.25%. Although 0.06% certainly falls within this range, the proximity to the zero bound leaves very little room for negative interest rates, an area the Fed has repeatedly noted is unwelcomed territory.
  • To help keep the EFFR within range, the Fed can adjust the interest rate it pays member banks on excess reserves (IOER), currently set at ten basis points (0.10%). A higher IOER incentivizes banks to park excess funds at the Fed as opposed to lending reserves to each other.
  • If the EFFR continues to fall closer to zero, we would expect the Fed to adjust the IOER higher to help steer money away from the federal funds market. By pulling some of the extra liquidity away from the funding markets, the adjustment will likely relieve some of the downward pressure not only on the EFFR but on other short-term yielding investments as well. And, in an environment flush with cash, any relief would be welcomed news for investors.

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