5/26/23 – Welcome to Summer!

Our expectation that traders would overlook fundamental data this week and instead focus on the debt ceiling stalemate proved prescient.  The one release that took the market by surprise were the minutes of the May FOMC meeting.  Thinking back to the Q&A session that followed that meeting, we interpreted Powell’s comments as closing the door on a June rate hike, but the minutes told a different tale.  The Bloomberg story following the release read “Officials were divided over path of rates with more favoring a pause.”  “More” is clearly not a consensus and traders immediately took notice and hit the bid in the futures market.  November Fed Fund futures, which had traded as low as 4.39% earlier this month, reversed and are closing out the week at 5.13%.  The other headline that caught our attention was that the staff was forecasting a mild recession in the fourth quarter but are not expecting to cut rates this year.  Our opinion is that there may be those that dissent at the June14th meeting, but Chairman Powell will not be one of them and his will be the overriding vote.

While Fed Fund traders were active, their market was not nearly as wild as the Treasury Bill market.  The Bill market was the most volatile in recent memory, as short maturity investors fretted about not getting paid when the Bill’s mature in June.  The June 8^th Bill closed at an elevated 5.48% last week only to trade as high as 7.00% yesterday.  That’s approaching the heady yields offered in the junk bond market.  At the other end of the spectrum, the May 30^th Bill traded below 3% as cash investors were eager to park their month-end cash in a security they felt certain would repay their investment at maturity.  To that end Fitch, the credit-rating operation, said this week that they are considering downgrading the credit of U.S. government paper to AA.    To state the obvious, capital markets do not like brinksmanship.

As we look at the week ahead, the most important driver of the market will be a debt ceiling deal, which is seeming increasingly likely.  With that out of the way, traders will be watching the May employment report on Friday.  There are Fed-watchers who think that a jobs report of more than 200,000 will be enough to persuade Chairman Powell to acquiesce to the hawks on the committee.  We don’t agree; unless the employment report is a blockbuster, the Fed will finally leave rates unchanged after nine consecutive hikes.