Four grab-bag topics today:
#1: Chair Powell’s Jackson Hole speech on Friday broke little new ground, and he waited until the very end to give his color on asset purchase tapering and the future path of interest rates. Here are the relevant 2 paragraphs (emphasis ours):
“We have said that we would continue our asset purchases at the current pace until we see substantial further progress toward our maximum employment and price stability goals, measured since last December, when we first articulated this guidance. My view is that the “substantial further progress” test has been met for inflation. There has also been clear progress toward maximum employment. At the FOMC’s recent July meeting, I was of the view, as were most participants, that if the economy evolved broadly as anticipated, it could be appropriate to start reducing the pace of asset purchases this year. The intervening month has brought more progress in the form of a strong employment report for July, but also the further spread of the Delta variant. We will be carefully assessing incoming data and the evolving risks. Even after our asset purchases end, our elevated holdings of longer-term securities will continue to support accommodative financial conditions.
The timing and pace of the coming reduction in asset purchases will not be intended to carry a direct signal regarding the timing of interest rate liftoff, for which we have articulated a different and substantially more stringent test. We have said that we will continue to hold the target range for the federal funds rate at its current level until the economy reaches conditions consistent with maximum employment, and inflation has reached 2 percent and is on track to moderately exceed 2 percent for some time. We have much ground to cover to reach maximum employment, and time will tell whether we have reached 2 percent inflation on a sustainable basis.”
The US Treasury market accurately anticipated Powell’s comments on tapering and 10-year yields actually fell slightly on Friday, to 1.31 percent. Still, they’ve spent most of August ramping higher from the 1.17 percent level at which they started the month. We expect yields to continue to rise slowly over the rest of 2021.
Fed Funds Futures, however, did read a slightly more dovish tone from Powell’s comments and repriced their policy rate expectations accordingly. The graph here comes from the CME FedWatch tool and calculates the probabilities of various scenarios at the February 2023 FOMC meeting based on current futures prices:
As you can see in the table, the odds of “no rate hike through February 2023” rose on Friday versus a week ago, from 30.0 percent to 35.2 percent. Those 5 points came from declining odds of either 2 or 3 rate hikes by then. The odds of one 25-basis point increase in Fed Funds remained essentially the same (39 – 40 percent odds).
Takeaway: US equities rallied to new highs on Friday because of this shift in future rate hike expectations, with markets already having priced in tapering of asset purchases.
#2: US corporate bond spreads and effective yields, putting recent levels in a longer-run historical context.
This chart shows investment grade spreads over Treasuries (blue, lower line) alongside high yield spreads (red, upper line) over the last decade. In both cases we’re at 10-year lows, and for all the right reasons. Corporate profitability is high, the Federal Reserve continues to support the US economy with low interest rates, and the odds of a recession in the next 12 months are (at most) slight.
Now, here are effective yields (what average marginal issuers pay bondholders) for investment grade paper (blue) and high yield (red) paper over the same 10-year lookback period. Unlike the prior chart, current levels are substantially below the prior cycle. Investment grade issuers paid 3-4 percent coupon rates from 2011 – 2020; their debt cost of capital is just 2 percent now. High yield issuers paid 6 – 10 percent pre-pandemic; now their debt cost of capital is just 4 percent, what used to be the upper end of the band for investment grade issuers.
Divide the high yield effective rate by the investment grade effective rate, and you get the data for this chart (1997 – present). The ratio between the 2 payouts averages 1.9x (HY essentially twice the payout of IG) and the one-standard deviation band is 1.5x – 2.2x. When we get around 1.5x or below, HY is too rich versus IG (as has occurred at the end of every cycle shown here). And, when we get above a 2.2x HY/IG yield ratio, high yield is attractive versus investment grade.
Worth remembering: there is a large duration difference between investment grade and high yield corporates just now: 9.7 years for the former, 3.7 years for the latter. If we are correct, and Treasury yields do continue to increase over the balance of 2021, then IG corporates (the LQD ETF, for example) will face a greater headwind than HY (e.g., HYG) assuming spreads stay constant.
Takeaway: US corporate high yield bonds pays 2.0x investment grade at present, so we’re right in the middle of the historical “relative fair value” ratio. We continue to favor HY over IG for its cyclical exposure and its yield pickup as well as lower duration risk.
#3: Updates on three US Google search trends we’ve been tracking:
First up: pandemic-related search volumes remain at high levels, as this chart from January 2020 to present shows. After dropping to 2021 lows in late June (as highlighted below), the delta variant’s spread pushed Americans’ attention back on the topic throughout July and August. The last 3 weekly readings are all roughly the same (82 – 86) and in line with December 2020’s high levels.
Takeaway: pandemic concerns continued to weigh on American consumer psychology throughout August. If the delta variant has really peaked in terms of health outcomes, then future consumer confidence may improve as we go into the last few months of 2021.
Second: American consumer interest in “back to school” shopping, while clearly affected by the prior issue, may have ended August on a stronger note. Google is not quite done tabulating the last week’s data (hence the dotted line below), but their tentative readings show “back to school” search volumes popped to a 2020 – 2021 high.
Takeaway: back-to-school shopping levels are an important indicator for Holiday consumer spending, and late August’s pop is the first heartening sign we’ve had during BTS 2021. Black Friday 2021 is only 89 days away …
Lastly, thinking about Tuesday’s upcoming Case-Shiller Home Price Index report, we got to wondering if Americans’ interest in the housing market has cooled in the face of record annual price gains. Here are Google search volumes for “Zillow” over the last 5 years. “Peak house” was in mid-2020 (noted below), but 2021’s search volumes (index levels 83 – 93) are still higher than 2019’s levels (71 – 92).
Takeaway: when the economic history of the American post-pandemic experience is written, “suburbanization” will be the title of the first chapter. Urbanites moving out of city centers, partly – remote workers seeking larger houses, a diaspora of cubicle dwellers searching for alternative work arrangements … All have contributed to a US housing boom which in turn drives demand for a range of durable goods and rewires where Americans live and shop. Nowhere in the developed world has the pandemic created such a shift, and the American economy has clearly benefited from it.
#4: One often-prescient analyst thinks Apple’s upcoming iPhone 13 could have built-in satellite connectivity. Fanboy website MacRumors posted an article over this weekend, citing a client note from Ming-Chi Kuo, which said:
“ … the iPhone 13 lineup will feature hardware that is able to connect to LEO (low earth orbit) satellites. If enabled with the relevant software features, this could allow iPhone 13 users to make calls and send messages without the need for a 4G or 5G cellular connection.”
Worth watching: the stock of Globalstar (symbol GSAT), a mobile satellite services provider. Earlier this year Qualcomm (one of Apple’s suppliers) announced its upcoming chipset would support communications with GSAT’s network. Now, since it is telecom companies that sell most iPhones, they may not allow for universal access to a GSAT (or other) satellite system. Still, any iPhone call/text traffic is more than any satellite system currently has. This is potentially big news (if true) for satellite companies.
Read the MacRumors piece here: https://www.macrumors.com/2021/08/29/iphone-13-to-feature-leo-to-make-calls-and-text/
And The Verge’s take on the same news here: https://www.theverge.com/2021/8/29/22647252/the-iphone-13-5g-leo-satellite
Takeaway: an iPhone with satellite call/text and perhaps even data capabilities would be a game changer, but we’ll wait for an actual announcement before we believe it. Still, the fact that it is theoretically possible is a great example of our thesis that disruptive technology (e.g., reusable rockets) is finally putting Moore’s Law into space.
Chair Powell Jackson Hole Speech: https://www.federalreserve.gov/newsevents/speech/powell20210827a.htm
CME FedWatch Tool: https://www.cmegroup.com/trading/interest-rates/countdown-to-fomc.html