Can You Two Step

At the first reading, I thought we were talking about some dance hall in Texas. They two step there. But, no, this time we are talking about what goes on in the House on the Hill. Although, this time some of the representatives may not be tapping their feet to the rhythm of this two-step dance.

The two-step extension being championed by the Speaker has been crafted in the fishbowl of congress. It has been crafted with only political realities and goals in mind. But it would get us past the critical holiday shopping period and the turn of the calendar year. Under the plan, one grouping of appropriations would be extended to January 19 and the other grouping would extend to February 1. It is not clear how the priority rankings were done for appropriations in each grouping. At least there has been the good sense to recommend extending before the critical Super Bowl that is to be held in Las Vegas for the first time. Perhaps, the odds on the timing of the federal budget may draw as much interest as what team will win.

It is far from certain whether the plan will be able to secure enough votes to forestall a government shutdown before the looming deadline this Friday. The circumstances induced Moody’s to place the debt of the USA on negative outlook. The rater did not want to be caught flat footed while the other agencies have acted already. The Treasury Secretary’s objections to Moody’s action were not especially credible given the deficit and debt trends at the federal level. If there is a shutdown, there is a better than even chance all the federal ratings for the nation will be below AAA.

While all the aforementioned is quite important to markets, today’s CPI reading and the outlook for rates remains front and center. The latest reading clearly indicates that the slowing of inflation is continuing. The core reading at 4% is a bit elevated but even that reading was lower. The rally in Treasury bonds was sharp and swift. The two-year shifted from the 5.0% level to 4.84% in what appeared to be an instant. The all-important 10-year maturity rallied significantly and now stands at 4.43%. Perhaps, mortgage rates will moderate soon and will assist in the soft-landing scenario. The expectation is quite high that the Fed will take no action in December. Any easing is not expected before mid-next year.

As anticipated, municipal volume has been accelerating of late. Some of this activity has been clearly linked to the two Fed pauses. However, some of the activity is also due to the regular flow of the municipal business. Transactions need to be accomplished before the calendar year end. Budget preparations command more government finance officials early next year.

Given the recent gains in the market, it stands to reason that there should be more year-end swapping and trading than was previously anticipated. Given the Fed pauses, it is a bit more comfortable extending maturities beyond 10 years. We will know there has been a real change in market tone when the outflows from the mutual funds change to inflows. But the growth in municipal ETFs and SMAs is also heartening.

John Hallacy