Dear Mr. Powell, Please Replenish the“Punch Bowl” Again
As the quarter ends, investors in unison are asking Chairperson Powell for one more rate cut by the Federal Reserve before year-end. Twice this quarter the Federal Reserve cut the Fed Funds Rate by 0.25% to reduce borrowing costs and keep the longest recorded economic expansion going. Investor consensus is one more cut in 2019 and a couple more in 2020 are just the recipe to keep the economy growing and stave off the trade policy and economic blues.
Economic data reports for the quarter remain mixed, suggesting moderate growth in consumer spending, but weakness in business investment. Consumer spending, 68% of Gross Domestic Product, rose just 0.1% in August after recording 2% gains over the previous five months. In business activity, both ISM Manufacturing and Service Indices reported orders for manufactured goods are contracting, while service sector growth is the lowest in three years.
As the risk increased this quarter, investors sought out safe haven investments, such as Treasury bonds, pushing demand higher and yields lower. We saw the bellwether 10-year U.S. Treasury decline by nearly 0.5% from its high point during the quarter to end at 1.66%. Declining rates also pushed bond prices for high quality corporate and mortgage holdings higher. The broad market index of high-quality bonds returned 2.3% this quarter, boosting the year-to-date return to 8.5%. An anchor pulling domestic interest rates lower has been $16 trillion of overseas debt with a negative yield. The fact that overseas savers are willing to pay a borrower for the right to own their debt shows how far central banks will go to fuel economic growth. For example, back in 2011 when the Greek government was near bankruptcy, its 10-year bonds paid a yield of 35%. Today, those same bonds yield 1.3%, lower than current U.S. Treasury levels.
As mentioned in our lead article, one sign of economic strength has been housing. Rising home values are a primary source of increased revenues for municipalities. This has strengthened municipality balance sheets and is supportive of outstanding debt and credit quality. Tax-exempt municipal bonds returned 7.3% year-to-date and 1.6% for the quarter. On a relative basis, municipal bonds have become more attractive as yields have not declined as much as Treasury or Corporate bonds. Municipal markets are partially isolated from those global drivers of interest rates that impact other bond sectors. This global economic “moat” is one reason our outlook for this segment is positive relative to other bond sectors.
We see the Federal Reserve refilling the monetary punch bowl with further cuts to its borrowing rate to head off declining economic growth. These cuts will help shield the U.S. economy and support our view for steady economic growth. Our outlook for bonds under this scenario is that most of the gains in the bond market have been achieved. It would take a catalyst from politics, trade policy or lower consumer spending for further advances.
Source: BTC Capital Management, Bloomberg LP, Ibbotson Associates, FactSet.
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