Market Update: May 21, 2023
This newsletter is a synopsis of a continual series of updates by a market analyst Mark Meldrum. Mark Meldrum is a CFA that provides weekly updates on the market, but they tend to be an hour long. Here is a synopsis of his video found here.
Interest Rates & the Fed
The debt ceiling story continues! Talks in Washington broke down, but the latest is that President Biden believes the Republican ask is “unacceptable” with June 1 is less than 10 days away. Meldrum thinks it’s inconceivable that rational minds won’t prevail at the last minute, but with all the “theater and political posturing” occurring globally (not just in the US), things could get… interesting.
Money market rates reflect mostly positive increases, except for the 1-month Treasury, which is down 17 basis points (bps). There’s a theory that, when the debt ceiling is removed, there will be around $1.4 trillion in T-bill issuance in the second half of 2023. Some people believe this much issuance would depress prices and increase yields, but Meldrum disagrees. He thinks these radical movements reflected in the rates is indicative of uncertainty, and there’s enough demand out there to absorb this hypothetical future supply that rates might actually drop on T-bills.
There’s a split between Fed speakers: those who are suggesting a hold, and those who are advocating for another rate increase—not a single Fed speaker mentioned a rate cut or being anywhere near a rate cut. Capital market rates all went up, so the market may be finally getting the message, especially when the target for cuts seems to be well into 2024. And we have 5 more speakers this week, so lots to pay attention to.
Credit default swaps (CDS) on US Treasuries, both 1-year and 5-year, are essentially unchanged. Total money market funds increased (again!) by $13.5 billion for a total of $5.34 trillion. The retail side drew in just over $14 billion, while the institutional side dropped by 616 million, and government funds increased by $9.5 billion.
The June 14 FOMC Meeting is about 3 weeks away, and April PCE & CPI reports are releasing this week. The likelihood on FedWatch still reflects a higher probability of a hold, but still a margin of possibility of another rate hike. Looking ahead to the predictions for December’s meeting shows a probable hold or even a rate cut at the very end of the year. So while no Fed speakers are signaling a cut until well into 2024, FedWatch shows a slight probability that we could expect it earlier, but Meldrum believes this will change as the year continues. The outcome of the debt ceiling will have some interesting effects and the Fed may be compelled to respond directly to the possible issuance of another $1.4 trillion in T-bills.
Real Rates, Federal Funds Rate, and TLT
Real yields have all increased for the second week in a row.
TLT, a major index made of up of long-term bond ETFs, dropped 304 bps (3.04%).
Before we cover the Federal Funds rate, a little background might be helpful…
Federal funds futures (FFF) are securities based on the rate that is 1) dictated by the Fed, and 2) the lowest rate set by banks to borrow money from each other for overnight loans of reserves on deposit with the Fed. Essentially, it’s the floor for interest rates when borrowing money, and FFF are derivatives of these loans that are cash settled on a monthly basis. The current projections for the curve on the FFFs are pricing in a rate cut near the end of 2023, lining up with the December 14 projections from FedWatch.
OAS & Corporate Spreads
US Investment-grade bond rates have ticked down just a bit, while issuance has increased $122 billion in May 2023, significantly beating last year’s May of only $4 billion.
Corporate debt, in addition to US Treasuries, seems to be another alternative for money to take shelter during a period of rising interest rates.
The Primary Mortgage Market Survey shows 30-yr. Fixed Rate Mortgages (FRM) are at 6.39% (up 4 bps from last week) and 15-yr. FRM are at 5.75% (no change from last week).
- Mortgage applications are down 5.7%
- Refinances down 7.67%
- Purchases are down 4.78%
These offset last week’s gain, but also reflects this stabilizing/evening out. Homebuilders are continuing to show increases, which means higher prices for home buyers. One developer reported an increase of 12.4%, week-over-week. This could explain the slowing we’re seeing in the activity of home sales. Less and less buyers are willing to accept the high price tag in a high interest rate environment; when the prospect of refinancing lays far in the future, more people are willing to wait.
If you’re a current homeowner, you’re not going to want to sacrifice your low-interest rate loan for one with a rate above 6% -- it’s just not a good move. So new home buyers are edged out of existing home sales, so they’re forced to buy a new home, only if they’re properly motivated.
Commercial property prices are down 15% from last year. Meldrum dives into GreenStreet.com and their Commercial Property Price Index to see how this breaks down further. Below is a table reflecting the price changes of commercial property types:
Table 2 – Estimated Change in Monthly Sales for Retail and Food Services provided by the US Census Bureau:
The table above provides a breakdown measuring the percent changes among different businesses, both on a month-to-month basis and year-to-year. On an annual basis, the steepest drops are in businesses like furniture stores, electronics/appliances stores, and gas stations, which represent the steepest drop of almost 15%. The biggest increases were in businesses like health & personal care stores, food services & drinking establishments, and food & beverage stores.
Meldrum reminds us to keep seasonal adjustments in mind. If we don’t account for seasons, the steep drop in January sales following the massive amount of December sales will look concerning, but accounting for what’s going on during these seasons is important to remember.
Leading Economic Indicators (LEI)
The Conference Board maintains a leading economic index that provides “an early indication of significant turning points in the business cycle and where the economy is headed in the near term.” The LEI declined 0.6% in April 2023 to 107.5; for comparison, the Index in 2016 was 100. They provide a chart (below) illustrating the fluctuations in the LEI since 2000:
When the blue line (representing the 6-month growth rate) reaches negative 4%, the Index flashes a warning signal that we’re in the contraction phase of the business cycle. Consecutive warning signals in a given period constitute a recession (represented with a red line) and, according to the chart, we’re in recession-signal territory.
Canada’s CPI was released last Tuesday and inflation for April 2023 reported a 4.4% increase (year-over-year) and 0.7% increase (month-over-month); both of these stats were above their estimated amounts. But Bank of Canada governor, Tiff Macklem, believes it’s far too early to think about interest rate cuts—sound familiar?
Canadian housing stats show home sales in April up 11.3% and the average home price is up $100K since January 2023! He even mentions a story circulating in a Canadian publication about the Toronto real estate market that says “Bidding wars are back! Bidding wars are back!”
Friday’s Market Rally
Biden made a public statement that “both sides [Democrats and Republicans] have agreed that we’re not going to default on our debt.” There’s no deal yet, and we don’t know what it’s going to look like, but that’s all the market needed to hear because it mostly bloomed green. The market rallied even before Jerome Powell’s discussion on Friday with Ben Bernanke, former Fed chair, before selling off and dropping into the red during after hours. The behavior of the market is unique: when it receives bad news, it often waits until it sees proof to react negatively; when it receives even a whiff of good news, it rallies quickly!
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