Market Note – October 3, 2022

By Hightower Great Lakes on October 3, 2022

Bond Market Volatility Impacted by BoE and PCE

Last week saw historically large moves in fixed income markets, driven by both the Bank of England’s (BoE) decision to launch an emergency bond repurchasing program to bail out UK pension funds and continued hot Core PCE readings in the US (+4.7% v. Est. 4.4%).

The Core PCE is the Fed’s preferred measure of inflation, which will continue to underscore the Fed’s hawkish narrative.

Even as parts of the economy are slowing, like housing, inflation has not retreated – driven by sticky components like household and other services which are, in turn, driven in part by rising wages.

On Wednesday, mortgages rallied 1.89%, while Corporate Investment Grade (LQD) rose 2%, both of which are the best single-day returns in history.

The 10-year Treasury yield rose above 4% on Wednesday afternoon for the first time since 2010, then rallied to end the week at 3.75%.

Corporate spreads widened through the week, High Yield by 50 bps and Investment Grade by 19 bps, finishing the week at +550 bps and +189 bps, respectively.

Municipal yields rose 10-15 bps across the curve, with the larger moves seen in the short end.

Lipper reported an eighth consecutive combined monthly outflow in municipals, resulting in a cumulative year-to-date outflow of ($91.5bn).

Bank of England (BoE) Throws a Life Preserver

Britain’s new government introduced a “mini budget” that would reduce taxes and increase levels of debt. This created acute financial instability as rates surged and the pound plunged.

Pension funds, which represent a significant percent of Great Britain’s GDP, were at risk – being required to pay collateral on “underwater” derivative positions.

The system quickly became non-functioning as pension funds searched for cash to pay off these “liability-driven investment” (LDI) hedging instruments.

The BoE stepped in as a buyer, spending 65 billion pounds toward long-dated securities to slow the surge in rates.

It was nearly a contagion event, and at the end of a turbulent week, many pension funds were still liquidating positions to meet collateral requests.

While the BoE may have stopped an immediate crisis by sending yields back to prior-week levels, experts say that Britain is not out of the woods, and uncertainty will remain when the BoE steps out of the market on October 14.

On Friday, S&P cut the AA credit rating for British sovereign debt from “stable” to “negative.”

Chart 1: UK Bond Yield Spreads¹

Significant volatility has also been experienced in U.S. credit markets – as blue-chip U.S. credit markets have their worst year ever, money becomes tighter and credit spreads widen.

Margin calls and forced liquidations could add further stress and chaos. The Fed is having an emergency meeting this week.

Markets are forward-discounting mechanisms, and the selloff has created opportunity for long-term investors – high yields in high-quality credit markets and historically attractive valuations in market-leading equity names.

U.S. Dollar Strengthens: Cycle of Risk

Investors continue to seek haven in the U.S. dollar as economic risks rise globally. On Friday, demand for USD in currency derivative markets surged to its highest level since March 2020.

As a country of importers, the U.S. consumer is able to purchase foreign goods for lower costs.

American consumers are beneficiaries of the trends while exporters are at a price disadvantage, selling their products in international markets and converting those revenues into USD at a lower value.

Many countries issue USD-denominated debt and then service that debt with local currencies – a difficult situation with the USD strengthening and interest rates rising.

In summary, investors are flocking to the U.S. dollar because of the rising global economic risks, and U.S. dollar strength further stresses global financial stability.

Chart 2: Currency Performance²

OPEC+ Expected to Announce Production Cut

OPEC+ members convene in Vienna on Wednesday, and they are expected to announce a second-sequential production cut.

A production cut is likely to be less impactful than the amount announced, because the group has consistently fallen short of their existing targets.

The group is said to be considering cutting output by more than 1 million barrels per day.

Chart 3: Theory and Practice³

Meanwhile, the Biden administration has continued to tap the U.S. Strategic Petroleum Reserves (SPR) – a program set to complete at the end of October.

U.S. emergency oil reserves are now at their lowest levels since 1984, while U.S. commercial crude inventories are below average, despite the SPR releases.

Return for Selected Indices⁴

Click here to read last week’s Market Note (9/27).

SOURCES

¹ Source: Reuters (chart)

² Source: Reuters (chart)

³ Source: Bloomberg (chart)

⁴ Source: Bloomberg

Disclosures

OCIO is a group of investment professionals registered with Hightower Securities, LLC, member FINRA and SIPC, and with Hightower Advisors, LLC, a registered investment advisor with the SEC. Securities are offered through Hightower Securities, LLC; advisory services are offered through Hightower Advisors, LLC.

This is not an offer to buy or sell securities. No investment process is free of risk, and there is no guarantee that the investment process or the investment opportunities referenced herein will be profitable. Past performance is not indicative of current or future performance and is not a guarantee. The investment opportunities referenced herein may not be suitable for all investors.

All data and information reference herein are from sources believed to be reliable. Any opinions, news, research, analyses, prices, or other information contained in this research is provided as general market commentary, it does not constitute investment advice. OCIO and Hightower shall not in any way be liable for claims, and make no expressed or implied representations or warranties as to the accuracy or completeness of the data and other information, or for statements or errors contained in or omissions from the obtained data and information referenced herein. The data and information are provided as of the date referenced. Such data and information are subject to change without notice.

This document was created for informational purposes only; the opinions expressed are solely those of OCIO and do not represent those of Hightower Advisors, LLC, or any of its affiliates.