Weekly Commentary | May 7, 2023

Macro Picture

Stocks were lower on the week on renewed worries about the banking sector.  Interest rates were lower indicating the bond market is also worried about something.  All this despite the fact that the jobs report was stronger than expected.

The Federal Reserve hiked rates for the 10th consecutive time bringing the Fed Funds rate to 5.25% on the upper bound.  The larger news was that they took out the previous sentence from their statement about anticipating “that some additional policy firming may be appropriate” and emphasized that future actions would hinge on incoming data and economic developments.

During the press conference Jay Powell hinted that the Fed Funds rate might be near the peak level for the cycle.  But he also left open the option to raise rates again by saying "a decision to pause was not made today."

Lastly, he noted that rate cuts, which are expected as soon as July, "would not be appropriate" in a world where inflation does not come down quickly. 

I still think the chances of a rate cut this year are low unless something really breaks.  While the Fed has shifted investors' focus from solely looking at inflation and labor data to include banking and credit stress, the chances of that causing a cut at this point is relatively low.

The jobs report for April came in at +253,000, above the consensus estimate of 179,000.  The prior two months were revised down by 150K offsetting some of that strength.  

It's hard to have a recession with the jobs market so strong.  The key is that the labor data is a lagging indicator- and very lagging- almost to the point of housing.  Initial jobless claims and JOLTs, or job openings are better 'real-time' indicators. 

Those have been inching higher although they are still relatively strong.  Keep an eye on those.  

When the economy starts to contract hard, the data will crack fast.  This is NOT going to be a slow moving shift into recession.  It will be fast.  Very fast.

Investors are buying the last Fed hike but we would caution investors that the opposite is probably warranted.  History shows you want to sell the last rate hike.  In fact, The Flow Show this week from BofA-ML had the same sentiment.

Instead, you want to buy the first rate cut.  That is when the market has likely fallen and the opportunities are abundant.

CEF Market Review

Discounts widened out this week as markets reacted to the added risks and volatility.  The VIX rose from multi-year lows back to 19 (which is is still relatively low).  Anytime the VIX rises by several points in a week, it is highly likely that CEF discounts have widened as well.  

Taxable bond CEFs are now at a -6.9% average discount, which is the 84th percentile.  This is the highest percentile other than the brief period during the SVB failure.  

Muni discounts have widened back out as well touching the widest levels of the cycle at -10.85%.  That is back to the 99th percentile. You can see that the current levels are on the far -left tail of the distribution.  This is a rare event outside of a recession.

Tax-exempt bond CEFs are one of the cheapest sectors on a long-term z-score basis. The next cheapest sectors are MLPs, loans, hybrid, and preferreds. 

The most expensive sectors are utilities, taxable munis, global income, convertibles, and EM debt. 

Muni CEF discounts widened by nearly 1% on the week, despite the fact that interest rates fell.  Those lower interest rates caused the NAVs of the muni CEFs to rise by more than half a point on the week.  A half a point move on a muni CEF NAV is a very strong week. 

We also had EM equity do well along with mortgage funds.

The worst sectors were preferreds, MLPs, and equity funds.  Preferred CEF NAVs were down more than 4% on the fallout of the First Republic Bank failure the week before and further banking worries hitting PacWest and Western Alliance banks.