Transcription:
Chip Barnett (00:03):
Hi, and welcome to another Bond Buyer podcast. I'm Chip Barnett, and my guest today is Tracey Manzi. She's the senior investment strategist at Raymond James. And we're going to be talking about the fixed income market and focusing in on that today. Welcome to the Bond Buyer, Tracey.
Tracey Manzi (00:22):
Well, thanks so much for having me here today, Chip, really great, great to be here with you.
Chip Barnett (00:26):
Could you first tell our listeners a little bit about yourself?
Tracey Manzi (00:30):
Sure. So I'm a senior investment strategist here at Raymond James. I've been working in the investment management industry for well over 30 years now. I started out my early career working on the buyside as a fixed income trader and analyst. Then I moved over to consulting and now I'm doing investment strategy here at Raymond James.
Chip Barnett (00:57):
Okay, thanks. Well, let's dive right into it. What shape are the fixed income markets in right now? I mean Treasury, munis, how are they doing?
Tracey Manzi (01:07):
Well, let me just kind of give you a brief overview. We've certainly had a lot of shifting narratives over the last few years, Chip, and I'd say right now the biggest trend that we're seeing has been that upward shift in bond yields since the pandemic lows that we did have. If you recall a couple of years ago, 10-year Treasuries hit 50 basis points. Today we're sitting here at multi-decade highs kind of across the yield curve, and I would say the general consensus coming into this year is that bonds were really attractive, and I still believe that to be the case. Earlier this year when we had all that banking term, we did see a sharp decline in Treasury yields were 10-year Treasuries have got down to around 3.40. However, the cracks in the system that the market was expecting really weren't long lasting.
(02:02)
What we've seen is that the economy since then has been doing a lot better than expected. So that the recession that everyone's been calling for has really been delayed and that has pushed yield higher again. So right now we're sitting here with 10-year Treasuries right around 4.18, 4.19, kind of getting close to their prior peak again, and kind of throwing a little bit of the issuance talk that we've had from the Treasury Department lately, that momentum has really been leaning in favor of higher yields in the near term. But of course, we're also seeing the fact that the market continues to anticipate that we are near the Fed ending its tightening cycle, even though Fed officials continue to say that rates will stay higher for longer. But what I really think is that we're going to need to start to see some softer than expected data, particularly on the jobs front, kind of reverse that trend that we've seen in 10 year Treasury yields.
(03:08)
And while the backup in yields really has been counter to views, I do think when you look forward and you put in the fundamentals of slowing growth, declining inflation, that will be supportive of lower yields going forward. And in fact, we have a 10 year Treasury call that yields can fall back to that three and a quarter, three and a half percent level over the next year. So we're a little off sides, but we do think that the trend should be lower for yields going forward. Now talking about the corporate credit curve, I know you mentioned munis as well, we can talk about that as well. But on the corporate credit side, I would say that corporate credits have been very well behaved, which in a way is not all that surprising given that we're in the late stages of an expansion and we really haven't had that much of a destruction in earnings.
(04:04)
High yield spreads, I would say have come in around a hundred basis points so far this year. So really not pricing in any chance of a recession, although I do expect that to be short-lived.
And on the muni side, I'd say that the muni market has largely followed the general uptrend that we've seen in Treasury yields. However, on a relative basis, when you look across the muni curve from the short end to the long end, I'd say that the short end of the curve is trading kind of on the expensive side. When we look at the relative value analysis, we tend to look at the muni to treasury ratio and that ratio is sitting down at around 65 versus its long-term average. But I definitely think that there's value in the in the muni market on the long end of the curve. So we do think that that's an opportunity for investors there to grab a little excess duration going forward. And plus when you kind of throw in the fact that we're approaching that summer seasonal time period in the muni market where they tend to have what they call this net negative supply dynamic where there's more calls and redemptions than there is new supply, I think that'll add some nice support to the market going forward.
Chip Barnett (05:20):
Thanks. What do you think the economic data is telling us right now?
Tracey Manzi (05:26):
Well, Chip, if that's a good question. I'd say that the economy continues to defy predictions of us being in a recession and as our CIO Larry Adam has pointed out pretty much for the better part of a year. Now, this recession, when it finally arrived, we'll be the most widely telegraphed recession on record. But what we've seen over the last couple of months, as I mentioned with the economic data coming in a little stronger than expected, is that that most widely telegraph recession is turning into the most delayed, if not canceled, recession on record. In fact, Larry just wrote about that in one of our weekly publications that we put out to our advisor base. There is no doubt when you look at the data in the U.S., it has been much stronger than expected over the last couple of months.
(06:20)
I mean, we've seen jobs growth remaining fairly strong with the unemployment rates sitting at right around a 53 year low, three and a half percent growth in the first quarter, in the second quarters come out much better than expected thanks to that pickup that we've seen in fixed investments in the second quarter. And even the housing market, which has been under a lot of pressure as the Fed has raised interest rates over the last year, we're also starting to see signs that that's starting to rebound, which I think is a bit surprising given like I mentioned, the pace and the magnitude of rate increases that we've seen over the last year. However, when we look on the other side at some of the more traditional indicators of a recession, we've got an inverted yield curve, we've got manufacturing activity being weak, leading economic indicators have been negative for 13 consecutive months and new orders and some of the manufacturing business surveys, they've been particularly soft.
(07:21)
So I think right now what you're seeing is there's been a lot of crosscurrents in the market really making it difficult to get that recession call right. And what that's done is you've seen a ton of strategists on the street canceling and delaying their recession calls, and the narrative has been shifting to the U.S. just might escape a recession and have what economists call is soft landing. And while I think it's plausible, I'd say that soft landing are very rare. In fact, when we go through our analysis, if you look back at the last 10 tightening cycles, going back to the early 1970s, the Fed was only able to engineer a soft landing twice over those time periods in '83 and '84 and then of course in the '94 and '95 period. So I would say that when we look at our view, the CIO team under Larry still in a camp that we do expect to see a mild recession, and that's really based on four key reasons, which Larry wrote about in our weekly publications that we put out to the advisory base.
(08:35)
And that's largely just based on, again, the four reasons — tailwinds to the consumer starting to fade, so you're seeing that excess savings being depleted, we've got student loan repays repayments starting, you have higher credit card balances and then higher interest rates on credit cards cutting into disposable incomes. Second, we're seeing cracks in the labor market form, not to the extent that we're seeing widespread layoffs, but when you kind of peel back to the onion a little bit, there are some signs of softness starting in some of the leading indicators of the labor market. We're seeing job openings fall, quits rates, ease temporary workers or temporary jobs are now declining, and that tends to be a really good precursor to a weakening labor market. We're also starting to see a pullback in the average work week. So again, cracks are forming in the labor market. Another interesting dynamic that causes us to believe that we will see a mild recession going forward is the fact that services spending is starting to get fatigued.
(09:38)
And in the environment that we're in right now, we don't expect to see good spending offset that. So you're seeing the kind of service spending, things on domestic airlines or starting to fall restaurant activity, when we look at some of the real-time indicators that's starting to soften, and even in the theme parks, Disney and Universal, they're reporting weak attendance. But unlike the pandemic where you had that big downshift in spending and a big uptick in good spending, we're not expecting good spending to offset that. And finally, as I mentioned earlier, that CapEx surge that has been supporting GDP growth in the second quarter of this year, we don't expect that to be sustained in an environment that we're in where you have really weak demand and very high borrowing rates. So yeah, there's resilience in the economy, but we haven't given up on our call that we do expect to see a mild recession.
Chip Barnett (10:39):
Okay. What do you think is the most important factor influencing the markets right now?
Tracey Manzi (10:45):
Yeah, good question, Chip. We've been talking a lot about this and getting a ton of questions on this from our advisors when we're out doing conferences, but I'd say that the number one factor influencing the markets right now just continues to be inflation. It's the most widely talked about thing that everybody is focusing on.
On a good note, we've just come through a period where you've seen 12 consecutive months of declining or disinflation where we've had the headline inflation number measure go from around 9% to about three and a half percent where it is today. But there's some interesting cross currents going on right now, and the market is not entirely sure where this is all going to shake out or even what the Fed's reaction function is going to be. On the one hand, we're starting to see an uptick in gas prices. I'm sure you see all that when you go to the pump and you see gas prices moving higher, and that could very well impact the headline inflation numbers over the next couple of months.
(11:50)
You still see wage pressures being elevated, and it's kind of in the news all the time with a lot of these strikes and labor negotiations that we've been seeing. And we're also in a period in the calendar year without those easy year over year comps or what we call base effects, we're really starting to get tougher. And as they say in the economist world, the last mile is going to be the toughest. So there's quite a few market pundits and even our investor base that is worried about the fact that you'll see a re-acceleration in inflation like we had in the seventies and the 1980s. But yet on the other side of the coin, we are starting to see a slowdown in the pace of the acceleration, if not declines in inflation. We're seeing it in airline prices going lower, we're seeing it in used car prices lower and shelter costs, which is the biggest component of the CPI, which is responsible for roughly 90% of the rise that we're seeing in inflation, you are starting to see that start to ease. So I think that you've got this dynamic where we've got a tug of war between those who think that you'll see a re-acceleration and sort of the disinflationary process that is continuing to unfold, keep the markets a little bit on edge, but we do think that inflation's likely to move lower going forward.
Chip Barnett (13:19):
And we'll be right back after this important message.
And we're back talking with Tracy Manzi of Raymond James looking at the economic landscape. What's your opinion on the outlook for fixed income securities in the near term?
Tracey Manzi (13:37):
Okay, so our outlook on the bond market is we think that bond valuations right here are really attractive on the bond side and that's largely because we think growth is going to slow. We think inflation, even though we may have a little bit of near term pressure, is going to continue to grind lower, and ultimately this will cause the Fed to reverse course and start easing in 2024. So I would say that this is really good news for high quality securities such as mortgages, munis, Treasuries, and even investment-grade credit. What we've historically seen that once the Fed pauses and easier policy is on the horizon, that is when 10 year Treasuries in the Treasury market tends to perform well. So not only will investors be able to clip a really healthy coupon yield depending on where you are on the curve or what sector of the market, something like 4.5% to 5.5%, you're going to get that one time impact of declining interest rates because historically after the Fed pauses its interest rates cycle, you do see its interest rate cycle.
(14:51)
When you do see interest rates begin to fall. I'd say that we're a little bit more cautious on the speculative grade side of the fixed income markets, things like high yield, and if any one of your readers been following our views, we've bet underweight high yield relative to the higher quality sectors. While all in yields for high yield are attractive, where investors can earn anywhere from eight to 8.5%, we're just a little bit more cautious as we see spreads incredibly tight relative to where they've been historically. And typically when you get into the late stages of an economic cycle or a tightening cycle, that is when you start to see a lot of pressure come in the high yield market. And that's where spreads tend to widen once the economy moves into a recession. Since we're still calling for a recession, we think there's room for spreads to widen from here. So we think it makes a better sense to be up in quality in your fixed income exposure.
Chip Barnett (15:51):
How about farther out, maybe a more long-term look into 2024, an election year?
Tracey Manzi (15:57):
Yeah, so the election year doesn't really impact the fixed income market too much. But when we think about what's going to happen longer term and into 2024, we do think that the yield curve will begin to normalize, but still probably stay inverted just given the fact that the Fed wants to keep rates sufficiently restrictive in order to ring out the last of those inflationary pressures. But ultimately, we do think that yields will move lower. We do think that there's scope for the 10 year Treasury to move to that 3% level over the next year, if not lower, if there's an economic event or sometime type of shock that triggers kind of a more pronounced downturn than we're expecting.
I'd say the big wild card for 2024 is the amount of supply that we see hitting the market right now. And it's been talked about quite a bit, not only with the Fitch downgrade, but also with the Treasury department coming in and kind of ramping up their issuance as deficits are getting higher.
(17:06)
I think that that's going to kind of weigh on the market at least in the near term. But what we do see that is at the near term factor, I would argue that the macro fundamentals are going to matter more. And so with the market, it does seem to be concerned over the next couple of months. I do think that those fiscal dynamics just means that when you look over the long-term economic cycles are probably going to be a little bit more pronounced than what we've seen in the past. So less appetite for more fiscal spending just given the dynamics we're on. And probably less appetite for monetary authorities to kind of goose the economy just given where the flack that they've got over their transitory call. So again, we think next year we will continue to see normalization in the yield curve and lower on yields.
Chip Barnett (17:57):
Do you have any last thoughts for our listeners?
Tracey Manzi (18:00):
There's two main points I wanted to add. Thanks for asking, Chip. One of the questions that we get most often asked from our advisor base is really how to position on the curve, given the fact that we have a deeply inverted yield curve right now, which just basically means shorter term maturity yields are higher than longer term maturities. And there's a lot of people right now chasing these 5.25%m 5.5% yields that you have on money market funds. And I totally understand because given the fact that we've had no yield whatsoever to be had in the fixed income markets for kind of well over a decade, but I think investors really need to be cognizant of reinvestment risk. So while you do have that nice coupon, that you can click for the next year but when that maturity comes and you have to reinvest it, you're most likely going to be reinvesting in lower yields.
(18:57)
So it might make a little bit more sense just given the backup that we've seen is to perhaps add a little bit of duration exposure to your bond yield.
And I guess the other point that I think is really important for investors to think about is from the asset allocation perspective. For so long with the low bond yields that we've had, people have had a very low allocation to bond yields, or they've had to take a lot of more risk on their bond side of their portfolio in order to just generate yields. But given the big reset that we've had in the bond market, investors no longer need to do that. High quality bonds offer really attractive yields, and kind of the silver lining of all this turmoil that we've had over the last couple of years is investors can now dial down the risk in their portfolios again, without giving up a lot. In order to do that, it's important to keep those points in mind.
Chip Barnett (19:57):
Tracey Manzi of Raymond James, thank you very much for being here with us today.
Tracey Manzi (20:02):
Thank you very much, Chip. I appreciate it.
Chip Barnett (20:05):
And thanks to the listeners of this latest Bond Buyer podcast. Special thanks to Kevin Parise who did the audio production for this episode. And don't forget to rate us, review us and subscribe at www.bondbuyer.com/subscribe. For the Bond Buyer, I'm Chip Barnett, and thank you for listening.