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BMT Monday Market Insights – November 22, 2021

In this week’s Market Insights, we cover the continued improvement in the U.S. labor market, the record issuance for high yield bonds, and consumers’ early start to the holiday shopping season.  In our Chart of the Week, we discuss higher U.S. Treasury yields, notably in the five-year area of the yield curve.  Finally, we highlight investors’ expectations for rate hikes in 2022 relative to Federal Reserve’s projections.

Top Weekly Themes

  • The Labor market continues to improve – The September Job Openings and Labor Market Report (JOLTs) report released earlier this month indicated further signs the labor market is improving.  The number of job openings remained plentiful, with September marking the fourth consecutive month job opportunities were above 10 million, and the fifth consecutive month openings exceeded the number of unemployed workers in the labor force, roughly 7.7 million in September.  Jobs were abundant, while a record number of individuals voluntarily left their organizations.  We believe the labor market will continue to improve this year as more individuals become available for work.  Labor supply bottlenecks, including healthcare concerns and now-expired enhanced job and childcare benefits, will likely ease as more individuals are eligible for vaccination.  Knowing that there are a healthy number of job opportunities awaiting job seekers should support a continued decline in the 4.6% unemployment rate as we head into 2022.
  • Record year for high yield issuance – For the second consecutive year, the junk bond market has hit record issuance levels as companies take advantage of the low-interest-rate environment and strong investor demand.  At a time when most fixed income sector performance is in the red, the Bloomberg US Corporate High Yield Bond Index returned 4.35% this year through October 31.  The yield for the index has averaged roughly 4.05% compared to the 10-year U.S. Treasury yield of 1.42% during this time.  The additional yield comes with additional credit risk, but investors have easily absorbed the more than $430 billion supply issued thus far this year.  Issuer fundamentals look good given the strong U.S. economy, while current default rates are roughly near 2007 lows.  For accounts comfortable taking on the additional credit risk, we have been diversifying fixed income portfolios with high yield bonds and bank loans with a focus on the latter.  Although we like the return/risk profile for both sectors, bank loans provide some protection from rising interest rates given their short duration.
  • Holiday shopping starts early this year –Consumer spending is off to a good start this quarter, with retail sales increasing 1.7% in October, the highest since March.  Consumers added a broad range of products to their shopping carts with a focus on electronics and appliances.  Concerns of supply disruptions and bottlenecks weighing on inventory potentially added an extra degree of buying urgency during the period that may weigh on future spending.  Time will tell but, otherwise, a healthy report.  The positive data came shortly after the November 12 University of Michigan Sentiment Report showed consumer sentiment is at a 10-year low. Somewhat contradictory – low consumer confidence and yet high consumer spending.  High inflation is certainly weighing on consumer confidence levels, but not enough to deter consumer spending in October.  As we approach 2022, we believe consumer spending will benefit from an improving labor market that will also put upward pressure on confidence levels.  We expect a more normalized economy will help ease inflation concerns relative to today’s abnormally high levels.

Returns Table

EquitiesWeek(%)YTD(%)1-Year(%)3-Year(%)5-Year(%)Div Yield(%)
S&P 500(4.0)21.725.019.9117.701.26
Russell 1000 Value(5.1)16.619.911.1010.111.90
Russell 1000 Growth(3.7)22.727.028.4524.890.64
Russell 2000(7.9)9.718.113.3311.760.93
MSCI EAFE(1.3)8.312.211.0310.102.48*
MSCI EM (Emerging Markets)(2.1)(2.9)2.610.0910.282.24*
Fixed IncomeWeekYTD1-Year3-Year5-YearDiv Yield
Bloomberg Barclays US Aggregate1.0(1.2)(0.7)5.553.751.68
Bloomberg Barclays US High Yield – Corporate(0.1)3.55.37.456.334.74
Bloomberg Barclays Municipal Bond0.31.42.05.104.471.11
Bloomberg Barclays Global Aggregate x US (Country)1.6(5.9)(4.1)3.733.201.01
CommoditiesWeekYTD1-Year3-Year5-YearCurrent Level
Crude Oil WTI (NYM $/bbl) Continuous(16.4)35.147.28.85.165.6
Natural Gas (NYM $/mmbtu) Continuous(16.7)68.647.8(2.6)4.04.3
Gold NYMEX Near Term ($/ozt)(0.1)(5.9)(1.8)13.48.81,781.6
Copper Cash Official LME ($/mt)(2.9)23.625.215.310.69,571.0
Currencies1 Week AgoYTD1-Year Ago3-Years Ago5-Years AgoCurrent Level
U.S. Dollar per Euro1.121.221.201.131.061.13
Japanese Yen per U.S. Dollar115.45103.25104.49113.55114.41112.97
U.S. Dollar per British Pounds1.331.371.341.281.261.33
As of 12/1/21 (close). Three-year and 5-year returns are annualized. *Dividend Yield For MSCI EAFE and MSCI EM are from 10/29/2021.

Chart of the Week

Five-Year U.S. Treasury Yield (December 31, 2020 – November 15, 2021)

Source: Bloomberg Inc.

Takeaways

  • U.S. Treasury yields have notably increased this year, given strong U.S. economic growth, above-average inflation, and anticipation of less monetary policy accommodation.  Although the entire yield curve has shifted higher this year, the five-year area of the curve has been noteworthy given its recent rise in yield. 
  • The five-year U.S. Treasury yield has more than tripled this year, rising from 0.36% on December 31, 2020, to 1.25% as of November 15.  It has increased about 30 basis points so far this quarter as investors have been pricing in less accommodation from the Federal Reserve (Fed).
  • Within the BMT taxable fixed income strategies, we continue to focus on a shorter duration relative to respective benchmarks.  It’s important to remember that although higher bond yields generally lead to lower bond prices, the reinvestment rates from bond maturities will also increase.
  • Given the recent rise in the five-year area, we believe it presents an attractive reinvestment opportunity to take advantage of higher rates while maintaining a shorter duration relative to benchmarks.

Commentary

Estimated Number of Moves Priced in the US – Futures Model (June 4, 2021 – November 15, 2021)

Source: Bloomberg Inc.
  • Investors are comfortably pricing in at least two rate hikes next year based on federal funds futures trading. From the chart above, rate expectations have notably increased during the quarter, with the number of rate hikes more than doubling. 
  • Interestingly, the market is currently pricing in an extra rate hike compared to the September FOMC Members’ Summary of Economic Projections (SEP). The disagreement partly revolves around the future path of inflation and its persistency.  Few would argue that October’s 6.2% annual inflation, the highest in thirty years, is normal. The persistency is the million-dollar question that will undoubtedly have implications for future monetary policy.  More persistent inflation likely leads to a more aggressive Fed and vice versa.
  • Our rate expectations are more in line with FOMC’s September SEP, but we are watching the incoming inflation data very closely. Accelerating productivity combined with the fading inflationary impact from the massive stimulus, in our view, should put downward pressure on today’s high inflationary data.  If inflation subsides, the Fed will likely have more flexibility when making policy decisions.

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