In this week’s Market Insights, we cover the recent rise in short-term U.S. Treasury yields, the pick-up in consumer spending to end the third-quarter, and this year’s Treasury Inflation-Protected Securities performance within an environment of rising yields. In our Chart of the Week, we discuss the raising of the U.S. debt limit and its impact on short-term U.S. Treasury bill yields. Finally, we highlight the labor participation rate that has struggled to keep up with other improving labor market statistics.
Top Weekly Themes
- Short-term yields on the rise – The two-year U.S. Treasury yield has doubled over the past month, closing on October 18 at 0.43%. Investors have started forecasting a more hawkish Federal Reserve (Fed), contributing to rising short-term yields. When looking at the trading of federal funds futures contracts, investors are pricing in a 25-basis point (0.25%) rate hike in September 2022, followed by another rate hike in early 2023. Recent commentary from the Fed has opened the door for bond tapering to potentially begin this year and end sometime in the middle of 2022. Given this timeline, investors believe the Fed may start hiking rates just as tapering is complete. This sentiment is being driven by inflation data that has remained more persistent than many anticipated. In our view, supply disruptions may be peaking, just as we start to see at least some slowing in demand as we push further into 2022. With this in mind, we expect the Fed will likely need to see more evidence that today’s inflation is more sustainable and will act cautiously before adjusting its main policy rate higher.
- Consumer spending picks up to end the third quarter – For the second consecutive month, consumer spending beat expectations by increasing 0.7% in September following a revised 0.9% increase the prior month. The positive report was welcomed news given consumer confidence levels, which, according to the University of Michigan Sentiment Index, remain near their lowest levels of the past eighteen months. Despite the pick-up in consumer spending, U.S. economic growth is expected to have materially slowed in the third quarter from the roughly 6.5% annualized pace experienced during the first half of the year. According to the Atlanta Fed GDPNow GDP forecast, third-quarter GDP is expected to come in closer to 1.0%. Official data will be released on October 28. The spread of the delta variant along with rising inflation have weighed on consumer confidence levels and economic activity. It’s obvious that economic growth has lost some of its momentum. However, consumer balance sheets remain healthy as the unemployment rate continues to fall, now at 4.8%. There are signs the spread of the delta variant has peaked while individuals continue to get vaccinated. Economic fundamentals remain healthy while the Fed is expected to remain accommodative. Given this backdrop, we continue to believe the U.S. economy is well-positioned for above-average growth next year.
- High inflation adds a boost to Treasury Inflation-Protected Securities (TIPS) – major U.S. bond indices are in the red this year, with bond yields rising and prices declining. The Bloomberg U.S. Aggregate Bond Index and the Bloomberg Intermediate U.S. Government/Credit Bond Index are down -1.55% and -0.87%, respectively, this year through September 30, 2021. TIPS securities have been a top performer returning 3.51% during the same period. As inflation erodes the purchasing power of fixed coupons, it contributes to higher coupon payments for TIPS securities, a positive for performance. A TIPS par value rises with inflation, as measured by the Consumer Price Index. At BMT, we have a 5.0% weighting to TIPS within the BMT taxable bond strategies. We believe TIPS adds further diversification to a portfolio of nominal U.S. government securities and corporate bonds while offering some inflation protection. Given the uncertainty surrounding the inflationary environment in the months ahead, we continue to believe having a modest allocation to TIPS within the portfolio should be beneficial if inflation surpasses expectations.
|Russell 1000 Value||(5.1)||16.6||19.9||11.10||10.11||1.90|
|Russell 1000 Growth||(3.7)||22.7||27.0||28.45||24.89||0.64|
|MSCI EM (Emerging Markets)||(2.1)||(2.9)||2.6||10.09||10.28||2.24*|
|Fixed Income||Week||YTD||1-Year||3-Year||5-Year||Div Yield|
|Bloomberg Barclays US Aggregate||1.0||(1.2)||(0.7)||5.55||3.75||1.68|
|Bloomberg Barclays US High Yield – Corporate||(0.1)||3.5||5.3||7.45||6.33||4.74|
|Bloomberg Barclays Municipal Bond||0.3||1.4||2.0||5.10||4.47||1.11|
|Bloomberg Barclays Global Aggregate x US (Country)||1.6||(5.9)||(4.1)||3.73||3.20||1.01|
|Crude Oil WTI (NYM $/bbl) Continuous||(16.4)||35.1||47.2||8.8||5.1||65.6|
|Natural Gas (NYM $/mmbtu) Continuous||(16.7)||68.6||47.8||(2.6)||4.0||4.3|
|Gold NYMEX Near Term ($/ozt)||(0.1)||(5.9)||(1.8)||13.4||8.8||1,781.6|
|Copper Cash Official LME ($/mt)||(2.9)||23.6||25.2||15.3||10.6||9,571.0|
|Currencies||1 Week Ago||YTD||1-Year Ago||3-Years Ago||5-Years Ago||Current Level|
|U.S. Dollar per Euro||1.12||1.22||1.20||1.13||1.06||1.13|
|Japanese Yen per U.S. Dollar||115.45||103.25||104.49||113.55||114.41||112.97|
|U.S. Dollar per British Pounds||1.33||1.37||1.34||1.28||1.26||1.33|
Chart of the Week
- On October 14, President Biden signed legislation raising the U.S. debt limit by $480 billion, allaying fears of an imminent U.S. default. U.S. Treasury Secretary, Janet Yellen, previously stated that the U.S. government would likely run out of cash by October 18.
- The chart above does a nice job of capturing the market risk investors had associated with the debt ceiling. Although we believed it was very unlikely the U.S. government would miss a coupon and/or principal payment, investors were pricing in some probability of a U.S. default. The chart represents the U.S. Treasury bill maturing on October 28 and shows the spike in yield as the deadline neared.
- Unfortunately, the increased debt limit is only expected to provide the Treasury enough cover until early December and maybe a little longer, depending on the Treasury’s cash inflows and outflows.
- Our position remains that the likelihood of a U.S. default is very low. However, so long as the issue remains outstanding, expect market volatility to increase. Both sides appear to be digging in for another standoff. Senator McConnell has already expressed his unwillingness to support any deal and will defer to the Democrats to resolve the issue. Investors who missed out on the spike in specific short-term U.S. Treasury bills the first time around may have another shot as time passes and the U.S. Treasury spends down its cash position while the debt ceiling remains unresolved.
- When looking at job market data, it’s obvious there has been steady improvement since the early days of the pandemic. The unemployment rate has fallen to 4.8%, while weekly initial jobless claims in early October dropped below 300,000. Worker confidence has picked up with more individuals leaving their jobs – the “quits rate” approached 3.00% in August, a record high.
- Interestingly, the labor force participation rate has remained stubbornly low. Workers have been slow reentering the labor force. The chart above captures the participation rate over the past 18 months. As one can see, after initial improvement through June 2020, it has flatlined since.
- It’s important to note that the participation rate is often referred to by Fed Chairman Powell when discussing the overall health of the labor market. A lower than desired participation rate, if it persists, would be another reason for the Fed to be patient when considering increasing its benchmark policy rate.