We Got the May Flowers!
Bond yields hit a ceiling in May and retreated lower in a sign that investors may believe most of the Fed’s rate hikes have been priced into market yields. All points along the Treasury yield curve between one and ten years moved a bit lower from April month end. This development was met with narrowing corporate bond spreads as well, all of which helped the Bloomberg Barclays U.S. Intermediate Aggregate Index achieve a total return of 0.85% for the month of May.
Still better was the tax-exempt municipal sector which enjoyed a very solid rebound: muni yields rallied consistently for the last couple of weeks, sending the total return for the Bloomberg Barclays Municipal Bond Index to 1.49% for the month.
Monetary policy finally commenced its formal tightening process on May 4 with the Fed raising the federal funds rate by 0.50% (or 50 bps). We wrote about this last month since it was so well-telegraphed by the Fed. In the meantime, Fed officials have mentioned on numerous occasions that two more rate hikes of 50bps are likely in June and July. Chair Powell has stated the Fed intends to tighten its policy stance “expeditiously to neutral” but with inflation so high, it’s pretty clear they will have to keep going into restrictive policy mode. Even if the Fed proceeds with these next two rate hikes, more 50bp increases could occur, but 25bps is also possible depending on developments in the economic data and financial markets. Fed officials are likely to continue using their ‘bully pulpit’ to talk tough on inflation since this narrative may help restrain consumer inflation expectations.
In a sign that higher interest rates are beginning to affect the economy, the new home sales report for April demonstrated clear weakening: sales plunged 16.6%. Some of this decline was surely due to higher mortgage rates which are now near 5%, but some are also likely due to higher home prices following the big price increases of the last couple of years. Data on March home prices showed a 20.6% year-over-year gain, the fastest growth in three decades. Of course, new home sales data can be quite volatile, but it was the fourth straight monthly decline and the second consecutive double-digit drop. We view this slowdown in sales as a healthy development that may allow builders to catch their breath, and if it curbs price increases then that would also be favorable for consumers. Later in the month, housing starts declined modestly and permits also fell, all of which corroborates a slower pace of activity in residential real estate.
With real estate slowing, it would make sense that the demand for durable goods would also start to recede. Indeed, May’s report reflecting March activity was weaker than expected and prior months were also revised lower. We expect this trend may continue due in part to the housing statistics noted above, but also due to the effects of higher inflation on items like appliances, furniture, and other kinds of durable goods.
The labor report for April, released on May 6, was stronger than expected, but the decline in the labor force participation rate was disappointing for anyone hoping that higher wages would bring more people back into the labor force. The unemployment rate remained at 3.6% and job openings still exceed job seekers by a wide margin, so consumers should still feel good about their financial security due to this vigor. In fact, the minutes from the Fed’s May meeting reported that “…business contacts continued to report difficulties in hiring and retaining workers. They observed that various indicators pointed to a very tight labor market.”
Retail sales also showed good strength, although the May report reflected March sales data and future months may now begin to slow as rising food and energy prices could temper spending in other areas.
One of the factors continuing to hinder supply chains, which affects inflation, is China’s zero-COVID policy which has resulted in major lockdowns that have shut down several economic activity centers. In an effort to bolster its battered economy, China recently introduced 33 new measures to support small businesses, consumers, investment, and supply chains while also cutting interest rates. It is also encouraging that Shanghai began a phased exit from its lockdown on June 1. Still, China will struggle to grow faster than the US this year, which would be the first time that’s happened since 1990. The world may have to get used to China being less of a factor in global growth, however, since its leadership appears determined to begin transitioning to greater self-reliance and less interdependence with Western economies. This will take time, but the trend does appear likely to cast a long shadow in myriad ways over the coming years.
On that cheery note, we will end this month’s commentary with the simple observation that the 2022 bond market correction has restored a great deal of value to bond yields. Investors should not be dissuaded by the negative price action that got us here, but instead should look at the current yield levels as an attractive entry point for anyone with a long term horizon. With higher yields now available, prospective returns are more alluring than they have been in years.
Important Disclosures
Maple Capital Management, Inc. (MCM) is an independent SEC Registered Investment Advisor with offices in Montpelier, Vermont and Atlanta, Georgia.
This commentary reflects the views of MCM and should not be considered to be investment or financial advice. MCM does not warranty these views and will not update this communication after the date of publication. Any mention of specific securities is done for illustrative purposes and the securities mentioned may or may not be held in client accounts. No assumption or assurance should be taken that securities mentioned will be safe or profitable investments.
For further information, please contact Steven Killoran at 1-802-229-2838 or at [email protected]. For further information about Maple Capital, including a copy of our informational brochure, please visit our website at www.maplecapital.com.
Index Definitions
The Bloomberg US Aggregate Bond Index is a broad-based flagship benchmark that measures the investment grade, US dollar-denominated, fixed-rate taxable bond market. The index includes Treasuries, government-related and corporate securities, MBS (agency fixed-rate pass-throughs), ABS and CMBS (agency and non-agency).
The Bloomberg Intermediate US Aggregate Bond Index is a broad-based flagship benchmark that measures the investment grade, US dollar-denominated, fixed-rate taxable bond market with less than 10 years to maturity. The securitized sector is wholly inluded. The index includes Treasuries, government-related and corporate securities, MBS, ABS and CMBS..
The Bloomberg US Treasury Index measures US dollar-denominated, fixed-rate, nominal debt issued by the US Treasury. Treasury bills are excluded by the maturity constraint, but are part of a separate Short Treasury Index. STRIPS are excluded from the index because their inclusion would result in double-counting.
The Bloomberg US Credit Index measures the investment grade, US dollar-denominated, fixed-rate, taxable corporate and government related bond markets. It is composed of the US Corporate Index and a non-corporate component that includes foreign agencies, sovereigns, supranationals and local authorities.
The Bloomberg US Mortgage Backed Securities (MBS) Index tracks fixed-rate agency mortgage backed pass-through securities guaranteed by Ginnie Mae (GNMA), Fannie Mae (FNMA), and Freddie Mac (FHLMC). The index is constructed by grouping individual TBA-deliverable MBS pools into aggregates or generics based on program, coupon and vintage.
The Bloomberg US Corporate High Yield Bond Index measures the USD-denominated, high yield, fixed-rate corporate bond market. Securities are classified as high yield if the middle rating of Moody’s, Fitch and S&P is Ba1/BB+/BB+ or below. Bonds from issuers with an emerging markets country of risk, based on Bloomberg EM country definition, are excluded.
The Bloomberg U.S. Municipal Index covers the USD-denominated long-term tax exempt bond market. The index has four main sectors: state and local general obligation bonds, revenue bonds, insured bonds and prerefunded bonds.
