August 25, 2021 | Cameron Parkhurst
We will be keeping a close eye on the now virtual Federal Reserve policy meeting this week. We are hoping that it will provide more clarity as to the Fed’s thoughts and decision-making process about reigning in their current policy on monthly asset purchases. Currently they are continuing to buy $120 billion in various fixed income assets, mainly Treasuries and MBS. Obviously, with the uncertainty around the new COVID-19 Delta variant and its potential economic impacts, this decision will be a highly debated matter.
Inflation continues to be present, especially in areas around homebuilder supplies, etc. Gasoline is up significantly but has pulled back a bit in the latter part of August. Net of this, we do believe that we will continue to see it present throughout 2021-2022 at least. The interesting phenomenon for us continues to be that rates have not moved with inflationary numbers. This could be a lag effect in waiting on the Fed, but that is yet to be seen. Hopefully that picture will become clearer in the coming weeks post-symposium.
Speaking of the Delta variant, since it is a driver of many of the markets that we invest in, we would like to take a short minute to provide an update. Schools have now been in session for a couple weeks, and we are already seeing impacts. In our hometown metro-Atlanta area, cases appear like this within a couple weeks of school beginning session:
Atlanta Public Schools - 178 student cases, 41 staff cases, 958 school-based exposures with several more pending
Barrow County (Aug. 6) - 25 students, 19 staff
Carrollton City - 39 students, 8 staff, 89 quarantined
Carroll County (Aug. 6) - 24 students, 12 staff
Cherokee County - 480 students, 85 staff
Clayton County (since July 30) - 117 students, 62 staff
Cobb County - 822 combined students and staff
Coweta County - 157 combined
DeKalb County - 363 students, 139 staff
Fayette County - 157 students, 16 staff, 876 combined quarantined
Fulton County - 306 combined, 995 combined quarantined
Gwinnett County - 456 combined, 138 probable combined, 749 close contact combined
Hall County - 81 students, 23 staff
Henry County - 245 combined, 822 quarantined
Marietta City - 45 students, 9 staff
Paulding County (Aug. 8) - 43 students, 14 staff
Source: Atlanta Journal Constitution
This is a bit surprising on one hand, knowing that many counties have mask mandates. On the other hand, the Delta variant has shown to be more contagious than others and is filling up hospitals with patients both young and old. Importantly, some of these cases are from even previously vaccinated individuals. Most early-school aged children also do not have access to the vaccination quite yet. The continuing trend of population vaccinations is extremely important, as is herd immunity. If this new variant continues to explode, it could have impacts on the economy in general and on many fixed income sectors.
Thus far, there have not been widespread shutdowns, only isolated incidents. However, in looking at the graph above, if this continues, we could see economic impacts come back into the spotlight, and sectors like airports and convention centers struggling again. Hopefully the recent full approval of the Pfizer vaccine by the FDA with further promote the vaccinations of individuals who may have been sitting on the sidelines.
When looking at interest rates, with a combination of the Delta variant, and the Fed not tapering as of now, yields have come back down. The 10-Year Treasury for example has come back to paltry levels around 1.25% from a high just below 1.80% this spring.
Source: Bloomberg
Importantly, during this last Treasury rate move, munis did not participate in lockstep, and have become a bit more attractive. In some cases, we have been seeing levels at 70% of comparable Treasuries, whereas this was closer to 45% to 60% in months prior. There continues to be extremely strong demand for munis as large institutional demand is strongly outpacing supply.
One interesting article that we recently read on Bloomberg via their mid-day muni focus page, highlights an interesting phenomenon/rule where states and local municipalities can issue new debt forward of their expected call dates when retiring aged debt. This is a way that municipalities are getting around the inability to use refinancing tools like pre-refunding, and instead are requiring new issue buyers to step up to the plate months before issuance. These “delayed-delivery” bonds help to take care of demand but do come with risk. It allows municipalities to lock in rate risk if they believe rates will be going higher, allows supply to satisfy institutional demand, but makes the buyer assume the risk that rates could be higher by the issue date.
When bidding bonds, our primary focus is on the secondary market with only a couple day settlement. We typically see more value there, especially when buying odd lots. However, we do evaluate all this new issue information when making higher level investment decisions and hypotheses regarding rate movements (on both Treasuries and our target tax-free and taxable muni markets).
One last item that is newsworthy this month is the newly proposed infrastructure plan. Originally there seemed to be bipartisan support for a program like the Build America Program. The latest proposed bill does not include subsidized municipal bonds. While this is a disappointment (as more liquidity in the taxable muni markets is always good for our clients), we will continue to keep our pulse on this ever-evolving situation. Provisions could always be added back when negotiating it through congress.
With the infrastructure plan news above, spreads have compressed just a bit. However, we continue to label A-AAA taxable munis as our most favored sub asset class here. We can bid ample supply to service our clients and they are trading above yields that we would get in IG corporate land. The historical default rate comparison is significantly in favor of taxable munis over corporates, as we have shown before during discussions.
Source: Bloomberg
We continue to favor a laddered approach for most clients, ranging from 3-15 years, creating durations at or below benchmark. Importantly, as bonds roll down the yield curve, we have natural duration lowering and significant ability to continually refinance at rates that the market will give us.
As always, please take time to digest this information and reach out with any questions.
Thanks,
Your PeachCap Fixed Income Team
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