Fixed Income Commentary – September 2021

“It’s Time”

Imagine Dragons


Key Takeaways

August saw a slight increase in bond yields across the curve and continued strengthening of the economy. Fed Powell confirmed the likelihood of “tapering” the Fed’s monthly asset purchases by year end in his comments from Jackson Hole. Powell also reiterated his expectation that inflation will prove transitory.

August in Review

  • The 10- year Treasury yield finished the month with a yield of 1.31%, up 9 bps month over month.
  • The slight move higher in rates had most fixed income sectors negative on the month, with high yield being the exception, which was higher by 0.51%.
  • Munis ended their five-month streak of positive returns, finishing down 0.37%.

 


Commentary

If you were away in August, you didn’t miss much. For the month, Treasury yields changed very little, with most points along the curve increasing by 3-9 basis points. Even though that may not seem like much of a change, low starting yields result in minor changes affecting bond prices more than usual. As a result, the Bloomberg Barclays Intermediate Aggregate Index turned in a total return of -0.16% for the month.

The “big” news in August was Fed Chair Powell’s speech after the central bank conclave in Jackson Hole, although the meeting was virtual this year due to the increasing caution over in-person gatherings. This annual meeting of the world’s top monetary policymakers always receives a good deal of attention but seldom follows through with anything terribly noteworthy. Powell’s comments confirmed the likelihood that a reduction in the Fed’s monthly asset purchases, the “tapering” we have mentioned before, could begin later this year. He also reiterated his expectation that inflation will prove transitory, explaining how multiple factors have conspired that have resulted in elevated inflation measures but that most should subside in coming months.

While it’s not difficult to understand the Fed’s desire to be patient after such a shock to the global economy from the pandemic, it is difficult to accept the continuation of $120B in monthly purchases of Treasuries and MBS. Financial conditions are extremely accommodative so we believe the Fed should be tapering now in order to avoid creating excessive risk-taking on the part of market participants. Several Fed regional bank presidents have stated this view in recent weeks, although most are not current voters in the Fed’s FOMC rotation at the moment.

The bottom line: Jerome Powell is dovish, meaning he is favoring easy financial conditions rather than taking a hard line and ending the abundance of stimulus. This dovish stance is likely what the Biden administration also favors, and it could be designed to ensure his renomination for another term as Fed Chair. A similar inference was published in a Wall Street Journal editorial on August 30, calling Powell a “first-rate politician” for his Jackson Hole speech. Officially, his term as Chair ends in February of 2022, so it won’t be long before we find out his fate. Treasury Secretary Yellen has already indicated her support of his renomination. If Biden chooses to nominate another candidate, it would likely be to placate the more Progressive wing of the House Democrats, many of whom dislike Powell for being too cozy with Wall Street.

It’s time. In the past, strong GDP growth, record-setting stock prices, and higher inflation would have led to Fed rate hikes, or at least a halt to unprecedented accommodation measures. This Fed is taking a different approach, partly to try correcting some economic imbalances such as low wage growth, income inequality, and high unemployment for non-whites. These kinds of policy objectives are certainly laudable, but their rather sudden expression in the halls of the Fed carries risks. Perhaps the main risk is losing the credibility of the markets with respect to inflation. The Fed’s reputation as an inflation-fighter was won from many years of following through on its words and acting pre-emptively, which frequently received criticism from politicians who didn’t want the “punch bowl” taken away too soon. Now that the Fed is more politicized and is touting a broader set of policy goals, the scrutiny is intensifying. We worry there is too much reliance on the power of interest rates to cure all that ails this economy.

 

 

In terms of recent economic data, most reports signaled strong activity but with signs of a plateau. Some slowing would be expected due to the resurgence in COVID-19 cases and the renewed caution around social gatherings, while the supply chain issues impacting many industries also remain problematic. Now that September is upon us, federal unemployment benefits are also set to expire nationally, but this may have a silver lining if it results in some easing of the labor shortages affecting many employers.

Corporate yield spreads widened a bit in August but narrowed toward the end of the month, ending up just one basis point wider. Due to the fairly steady tightening on a YTD basis, coupled with lower Treasury yields, it feels as though some apathy is setting in among investors. Adding to this sense of indifference, MBS remain relatively unattractive due to continued Fed buying. Finally, municipal bonds have seen huge interest from investors this year but took a slight pause in August, at least from a performance standpoint, as shown in the data box.

In closing, we thank you for your interest — no pun intended — and we hope you are able to enjoy the long Labor Day weekend and the final days of summer.