Week of September 4, 2023

Dec Mullarkey, CFA , Managing Director, Investment Strategy and Asset Allocation

If you ever tire of the ocean of numbers that describe the U.S. economy, then there is always the Beige Book. It crafts a qualitative take on the data and is published eight times a year. The Beige Book aggregates anecdotes and pulses from across the 12 Federal Reserve Districts that cover America.

Its latest installment arrived this week. Right up front, the Beige Book noted that retail spending was continuing to slow, and that consumers may have exhausted their savings and are relying more on borrowing to support spending. Also highlighted was that most districts expect wage growth to ease in the second half of the year. The other big takeaway is that businesses are struggling to pass along cost increases, a challenge that may crimp profit margins.??????

All this suggests that the cumulative effects of U.S. Federal Reserve rate hikes over the last 18 months is helping moderate activity. This creates a persuasive argument that the Fed has already done enough, and that stalling and allowing time for the full picture to come into view could be the best strategy.

Sources: U.S. Federal Reserve, Bloomberg, 2023.

Linda Kong Ting, CFA , Senior Director and Credit Analyst, Asset Management

Corporate bond issuers delivered over US$50 billion in new issuance in just two days this week, with 30 names rushing into the traditionally busy post-Labor Day period. However, the composition of the new issuance was overwhelmingly tilted toward short- and intermediate-term paper with 10 years or less to maturity, with long-term paper making up only about one-eighth of the total.?

This reflects a broader trend according to our analysis, as the spread between the Barclays Aggregate Corporate Option-Adjusted Spread (OAS) and the Barclays Long Corporate Aggregate OAS has narrowed from a pre-COVID range of 40–65 basis points (bps), from 2014–19, to a current level closer to 20 bps, around the tights of the post-COVID range. This demonstrates the potential conflict between long pension plans, life insurers, sovereign wealth funds and other duration demanders who wish to immunize their portfolios and lock in equity gains, and corporate treasurers that have shunned issuing longer-duration debt in the hope that rates fall in the future. Therefore, even if back-end rates rise due to persistent inflation, stronger relative technicals for long corporates may persist, and the credit term premium could remain below pre-pandemic norms.

Source: Bloomberg, 2023.

Melissa Boulrice , Senior Director, Asset Management, Public Fixed Income

The Bank of Canada’s (BoC) decision this week to keep overnight interest rates unchanged was not a surprise given the recent weakening economic data. Earlier this month we saw June’s GDP contract, with a slight decline for the second quarter. Canada’s GDP is now tracking a little behind the central bank’s year-to-date estimate. Consumption growth and housing activity are also slowing, and the unemployment rate continues to tick up.

On the other hand, the BoC is still concerned about persistent inflationary pressures as it struggles to bring core inflation back to its 2% target. Given the lack of clarity, the BoC has still left the door open for future hikes, if needed. What set the week’s central bank meeting apart, however, was not the BoC’s decision nor its commentary. Rather, it was news that – in the days before the announcement – multiple premiers had sent letters to the BoC’s governor urging the central bank, an independent institution, to halt rate hikes. While a hold on rates by the BoC was widely expected already, the optics of potential political interference cast a shadow on this process.

Source: Bank of Canada, 2023.

John Bichajian III, CFA , Managing Director, Derivatives & Quantitative Strategy

Market participants can use derivative pricing to infer what the markets imply in terms of probabilities of future interest rate hikes and/or cuts. The current implied overnight federal funds rate remains above 5% out to the summer of next year, which is broadly consistent with projections from the Federal Open Market Committee.

Meanwhile, U.S. nominal GDP grew at an annualized rate of only 4.1% in Q2, while T-bills and two-year Treasuries trade with yields between 5%–5.5%. U.S. debt relative to GDP peaked in 2020 and had been falling due to monetization via increased money supply and velocity.

Given that the M2 measure of money supply has started to contract significantly over the past year, coupled with nominal GDP slowing in each of the last four quarters by an average of 110 bps and currently lagging short term rates by a large margin, this imbalance is unsustainable without rate cuts or monetary expansion, and will increase debt to GDP moving forward.

As existing debts mature and are replaced at higher yields, we expect that nominal and real GDP will continue to be forced lower. U.S. interest rates are unsustainable at these levels in our view, as they are likely too high for the country to afford. We continue to monitor forward rates implied by derivatives markets and anticipate seeing lower forward yields priced into markets in the next few months.

Sources: Bloomberg, St. Louis Federal Reserve, The MacroStrategy Partnership LLP, 2023.

The information may include statements which reflect expectations or forecasts of future events. Such forward-looking statements are speculative in nature and may be subject to risks, uncertainties and assumptions and actual results which could differ significantly from the statements. All opinions and commentary are subject to change without notice.

Market insights are based on individual portfolio manager opinions and market observations. These are observations only and are not intended to provide specific financial, tax, investment, insurance, legal or accounting advice and should not be relied upon and does not?constitute a specific offer to buy and/or sell securities, insurance or investment services. Investors should consult with their professional advisors before acting upon any information posted here.

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