Investors were clearly pleased with the end of the government shutdown, as the various “risk on” trades performed well in October. Fixed income returns were driven entirely by a demand for credit, as the Treasury market was mostly unchanged for the period.
As the government returned to work late last month, investors debated what impact the political squabble would have on the economy. Conventional wisdom was that the work stoppage and the collateral damage done to government-related business had weakened consumer and business confidence; especially since the squabble is likely to resume as the year comes to an end. Reflecting that, many Wall Street economists have lowered their Q4 GDP forecasts to below 2%. Surprisingly, the economic data released since the shutdown has been almost uniformly positive. Weekly claims for unemployment insurance continue to fall and the manufacturing sector, as measured by the purchasing manager indices, has accelerated. Most surprising has been the unexpected increase in Q3 GDP and the big jump in hiring as portrayed in the October jobs report. The GDP report was boosted by an inventory buildup, which jibes with the jump in manufacturing and is widely seen as being a drag on future GDP growth. However, due to unseasonably warm weather, the utility expenditure component of the report was down 0.3%, which is arguably beneficial for future expenditure and partial offsets the inventory effect. Money saved on utilities becomes available for discretionary spending. Unlike the “good news, bad news” GDP report, the non-farm payroll report was an unqualified positive. Economists had been expecting an anemic gain of 120,000 new workers. With more than 200,000 jobs added in October and an additional 60,000 in the August and September revisions was welcome good news.
Against that backdrop and with the fiscal uncertainty continuing to linger, investors were left to again debate the timing of the Fed’s taper plans. On this matter, no clear consensus has emerged as comments from members of the committee continue to send conflicting signals. Last week Atlanta Fed President Lockhard suggested that action could come as soon as December. Given Chairman’s Bernanke’s penchant for preparing the market well in advance of any change, we think that’s unlikely. The Fed has historically been loath to change policy in December when markets are materially less liquid and a policy change could have an outsized effect on asset prices.
While economists debated the timing of the policy change, corporations took advantage of the marginal fall in interest rates to issue debt. During the month, 106 investment grade deals totaling $108 billion came to market. That comes on the back of the $145 billion debt issued in September. Of that $108 billion, nearly a third was issued by financial institutions, more than half was issued by “A” or lower rated issuers, and the maturity breakout was evenly split between three-, five-, and ten-year notes. Despite the onslaught of new debt, investor appetite was voracious as evident in the narrowing in Barclays Credit Index from 137 to 126 basis points in the course of the month. Despite than narrowing of the credit spread, we continue to see attractive value in the credit markets.