Break On Through (To The Other Side)

Our title for this week’s commentary was inspired by one of the greatest American rock bands to come out of the 1960s. Break On Through (To the other Side) was the opening track on the Doors’ debut album and was launched as its first single. Although the song barely moved the needle on the record charts, it was a fan favorite for concert-goers. For market participants, we are all trying to Break On Through (To the Other Side) of this persistent volatility. Although it is difficult to predict when we get there, we continue to posit that some of the best investment opportunities can be found during periods of protracted volatility. Admittedly, these are the times when stakeholders are challenged to parse the noise and identify those signals having credibility and sound guidance. It certainly does not help the effort when every data point and every policymaker utterance is critiqued beyond necessary. While Fed Chair Jerome Powell headlined this week’s events with his semiannual two-day congressional testimony, Friday’s release of February employment figures held top billing. For much of his two-day appearance on Capitol Hill, Mr. Powell reinforced the Central Bank’s commitment to its dual mandate of full employment and price stability with the 2% inflation target very much without compromise. The Chair telegraphed his openness to a somewhat higher than previously forecasted peak in interest rates, citing above consensus economic data and indicating that policy can be effective without creating undue detriment to the labor market. In communicating a decidedly hawkish message, Chair Powell joins a number of his colleagues suggesting that a faster pace of rate hikes could be applied should circumstances warrant more aggressive moves. 

Upon conclusion of Tuesday’s Senate Banking Committee testimony, many market participants shifted their bets to a 50-basis point boost in the funds rate from what was widely anticipated to be only half that amount. Wednesday’s seating before the House Financial Services Committee may have conveyed a slightly less hawkish tone, but the elevated bets on a 50-basis point rate hike did not dissipate. Futures contracts were signaling just over forty basis points of tightening at the March FOMC meeting against a backdrop of a growing narrative of higher, faster, and longer. This was the backdrop until the release of February's employment report. With mixed data led by an above-consensus non-farm payrolls print, the bond market rallied on slowing wage pressure and rising unemployment as well as a flight-to-quality-bid, and the futures contracts have rolled back the anticipated terminal rate to just over 5.3% (current read) at the conclusion of the July FOMC meeting. 

Of course, this could all change with the release of February CPI, PPI, and retail sales, all to come ahead of this month's policy meeting. While our base case calls for a 25-basis point hike, should there be a collective heat wave in the data, we would likely find ourselves closer in alignment with a 50-basis point move. Although the economy has displayed surprising resilience, there is evidence of slowing momentum and even weak to negative growth across certain areas. We have also seen cracks in the consumer confidence foundation, which if intensifies, could catalyze a sharp pullback in overall consumer participation from the economic system. Having said this, the Fed’s latest Beige Book points to early-in-the-year economic resiliency with steady consumer spending and a stabilizing manufacturing sector, yet the future outlook is less encouraging according to the report.  

Municipal bonds put forth a good faith effort to flex some independence this week as the Treasury market succumbed to selling pressure while tax-exempts firmed-up along the curve Wednesday and Thursday. Munis received support from institutional activity and a busy primary market with strong competitive bidding and good pre-sale activity at mid-week amid noted advances in issuance. Since the beginning of the month, munis have been displaying uneven performance as technical headwinds have created uneasy sentiment and investor selectivity has become more pronounced. With cash still awaiting deployment, retail is quite discerning on structure and we are currently seeing a defensive focus on quality general obligation and essential purpose revenue bonds, inside of 20 years. Interest in laddered portfolios, particularly within the 2–8-year range, has been noted by our trading desk. With primary issuance down year-over-year and dealer balances tight, investor interest has been largely satisfied in the secondary, yet a more active primary has been helping to meet demand. We are also entering a period where reinvestment needs are relatively light. Overall, the rate volatility has generated a great deal of apprehension for both issuer and investor even though the asset class is in a good place. Although the rate uncertainty will persist for a while longer, investors are well-advised to deploy cash opportunistically and position their portfolios as defensively as possible, adhering to investment guidelines and suitability needs. Absolute yield levels are supporting institutional engagement even at tight spreads, and this is even more pronounced with taxable activity given the lack of taxable muni supply.