In this piece, we take key points from our firm's most recent Bond Policy Meeting and share them with our readers. Hopefully, this piece will provide some insight into the economy and fixed income markets and give you a sense of how our team is thinking about recent trends and developments.
Crawford Bond Policy
- We believe the U.S. economy is beginning to exhibit signs of weakness.
- This has become evident in reports of consumer confidence, consumer inflation expectations, declining credit card spending, and increased card and auto loan delinquencies.
- Overall, the economy continues to expand at “a solid pace” at the macroeconomic level, as described by Federal Reserve (Fed) Chairman Powell. However, there does appear to be softening at the microeconomic level, particularly at the lower end of the income spectrum.
- Consequently, our policy is not changing and remains positioned to outperform in a “hard” or “soft” landing scenario based on sector weights (bias to agency/municipal/defensive corporates) and yield curve positioning (longer duration).
- We remain watchful for risks to our outlook, including a: resurgence in inflation, Fed rate policy increase, or “no landing” economic scenario where the current Fed Funds Rate range of 5.25 - 5.50% is neutral. However, we consider these to be low-probability events.
- Our Core and Municipal strategies are positioned to:
- Preserve capital with a strong bias to high quality (sector and issuer credit strength).
- Benefit from total return as rates adjust to a more balanced economic environment (yield curve positioning and maturity extension).
- Produce a high level of current portfolio income (bias to higher-yielding spread sectors and above-average coupons).
Treasury Yields as of 6/12/2024 (Post-Fed Meeting)
- Nominal U.S. Treasury security yields moved lower across the curve between our May and June Bond Policy meetings, and the 3-month/10-year and 2-year/10-year Treasury curves inverted 13 and 7 basis points, respectively.
- Market-driven inflation expectations (measured by TIPs Breakevens) continue to decline and real yields were varied, reflecting mixed economic reports and optimism for the Fed to ease rate policy.
- Fed Funds Futures continue to reflect an expectation of one cut in 2024 with a 91% chance of a second cut. This illustrates a potential de-coupling of market and Fed expectations as the Fed DOT Plot indicates 11 of 19 Board members project one cut for 2024.
- Bond market yield movement since our May Bond Policy meeting reflects a combination of decreased (market-based) inflation expectations declining regressively across the curve combined with mixed real rates.
- This behavior has been driven by mixed survey and hard economic data reported during the period. It indicates a strong U.S. economy with grudgingly improved inflation metrics, a strong employment picture, and a lower-income consumer strata beginning to fade in terms of spending propensity and credit strength.
- While market-based inflation expectations (TIPs Breakevens) fell, consumer survey data has shown stubbornly elevated inflation expectations, which is weighing on confidence.
Corporate Bond Market
- Broad-based demand for high-grade corporates has continued despite a substantial increase in new issue supply.
- Year-to-date high-grade gross new issue volume is up 21% year-over-year.
- Demand is unlikely to subside, despite tight relative value (yield spreads), based on historically attractive absolute yield levels.
- Issuers are paying less relative to outstanding issues (concession).
- There is more in total orders relative to issue size (books).
- Yield spreads to attract orders from initial talk to final pricing are coming down more (compression).
- The fundamental backdrop remains supportive as indicated by first quarter corporate financial performance with S&P 500 Sales and Earnings growth up 4.18% and 7.86%, respectively.
- Investment-Grade Corporate Option-Adjusted Spread (OAS) evaluates the additional compensation investors require for credit risk being taken above a risk-free treasury security.
- Yield spreads remain compressed, but using Bollinger Bands to illustrate a 30-day moving average and two standard deviations above and below the average, the graph illustrates “breathing room” off the lower bound.
Municipal Bond Market
- Municipal bond “AAA” scale yields were mixed but higher across the belly of the curve since our May Bond Policy meeting.
- Municipal bond yields have been heavily influenced by record new issue supply. The timing of this supply is consistent with Presidential election years when issuers tend to front-load financing into the first half of the year to avoid unknowns in the fourth quarter.
- Gross new issue municipal supply year-to-date is 36% higher than the same period last year.
- Gross issuance in May of this year was 61% higher than in May of 2023 and 43% higher than the trailing 5-year average for the month.
- The week of June 3, 2024 saw the highest level of weekly new issue supply ($16B) since December of 2017.
- While summer months typically experience net negative supply, supporting bond prices, this year is likely to be less supportive with the election looming.
- Net new issue supply is expected to remain positive in June, become negative in July and August (supporting bond prices), and move back to positive in September and October.
- According to LSEG Lipper mutual fund flows, investor demand has remained supportive of bond prices with $11.5B in net inflows year-to-date.
- The overwhelming influence of supply on municipal yields since our May Bond policy meeting resulted in underperformance relative to U.S. Treasury securities during the month of May. This resulted in higher/wider Muni/Treasury ratios. This indicates improved relative value but still reflects relationships across the curve that are rich from a historical perspective.
Summary of Economic Projections & DOT Plot
- Revisions to the economic and policy path projections include:
- Modest increases to the projected unemployment rate in 2025, 2026, and Longer Run.
- Increases to projected PCE and Core PCE Inflation in 2024 and 2025.
- An increase to the projected Fed Funds Target Rate in 2024, 2025, and Longer Run.
- In summary, the Summary of Economic Projections and DOT Plot illustrate the Fed's continued expectation for a longer process in bringing inflation down to its 2% target level.
- There are now nine dots of 3% or higher in the Longer Run Fed Funds rate projection category, compared with seven dots in March. This signals a growing belief among board members in a neutral rate greater than 2.5%.
Disclosures:
Crawford Investment Counsel (“Crawford”) is an independent investment adviser registered under the Investment Advisers Act of 1940, as amended. Registration does not imply a certain level of skill or training. More information about Crawford, including our investment strategies, fees, and objectives, can be found in our Form ADV Part 2and/or Form CRS, which is available upon request.
The opinions expressed are those of Crawford. The opinions referenced are as of the date of the commentary and are subject to change, without notice, due to changes in the market or economic conditions and may not necessarily come to pass. There is no guarantee of the future performance of any Crawford portfolio. Crawford reserves the right to modify its current investment strategies and techniques based on changing market dynamics or client needs.
Material presented has been derived from sources considered to be reliable, but the accuracy and completeness cannot be guaranteed.
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