We have just had another interesting week dominated by Trumps antics in the White House. Putting aside the Trump theatre, the market appears to have reached the remarkable conclusion that the DOGE and now Congress cuts to fiscal expenditure will trigger an economic contraction – even in the March quarter of 2025. The word ‘absurd’ is not used lightly here. What are US economists & market strategists thinking? The asset markets are being steered by the narrative and not the facts.
- Employment is a lagging indicator by 6-9 months.
- A rise in unemployment from the DOGE cuts will only come very late in the quarter and there are more important forward indicators that suggest that US economic growth is in fact about to surge.
- Do they believe that a government can tax and spend to create a sustainable path for growth and prosperity? Not even Keynes believed fiscal expansion could achieve this outcome in the medium to long term – just smooth out the worst of contractions.
Economists – even at the Federal Reserve – are fond of pointing out that US employment has consistently weakened over the past 18 months. This is true, but the claim lacks perspective and so relevancy. Yes, the following is true and the basis for these economists claim:
- Monthly non-farm payrolls have weakened to @165,000 from over 200,000.
- Output per hour per person has stabilised.
- The unemployment rate has increased from near 3.5% to near 4%.
BUT:
- Non-farm payrolls surged to very strong levels post the pandemic because workers needed to be re-hired after being made redundant by the pandemic. The US government handled the pandemic very differently to the Australian Morrison government. In Australia employers were paid a subsidy to keep workers employed while in the US workers had to be unemployed to access welfare during the pandemic. Consistent with a stable GDP growth rate we have seen historically monthly non-farm payrolls average 125,000 growth per month. The current average is still well above this level.
- Output per person has stabilised after absorbing an enormous increase in immigration. The following chart provides much needed perspective as it shows the surge in population growth and that output per person has really only returned to its long-term range.
- The unemployment rate is still very low by historical measures and well below the Federal Reserve own measure of ‘full employment’ as an unemployment rate of 4.75%.
One of our favourite forward indicators – often by just one quarter- is US import growth. The track record of this indicator over the past 16 years is very strong with a decline in import quarterly growth proceeding a decline in GDP growth. Although there are always a lot of factors of work in the US economy it seems unlikely that with such strong import activity over the past 12 months and then the tariff driven surge in January that US GDP will show a decline in the March quarter. In fact, based on this indicator alone, the US economy may about to see a surge in growth. The reliability of this indicator and the decline in imports in the first quarter of 2024 may have been one of the signals that the US Federal Reserve relied upon when it cut rates by 50bps in September of 2024.
The ISM PMI data is often misrepresented and misused by economists & strategists that are struggling with conflicts of interest. The Purchasing Managers Index is a forward indicator of private sector purchasing by 6-9 months. Way back in mid-2023 (apparently now ancient history) the market was 100% convinced that the US economy would enter a recession in the March quarter of 2024 because both the ISM PMI Manufactures Index was below 50 (indicating a contraction beginning in the March quarter of 2024) and the US benchmark curve had turned inverse. Historically this combination of signals had a 100% success rate. At the time we argued that a recession would not occur and that these signals had been distorted by the nature of the pandemic disruption.
The chart below shows that the ISM PMI data is now unequivocally signalling an economic expansion 6-9 months ahead with the PMI manufacturing index joining the non-manufacturing above 50 at the last reading. It is worth noting here that both the Import and ISM PMI Manufacturing indicators predicted the contraction that commenced in the March quarter of 2020 that aligned with the commencement of the pandemic lockdowns.
Interest Rates
US yields fell over the past week with weak economic data, a steady inflation print, comments from the Treasury secretary stating lower yields are wanted and a flight to safety as investors switched from equities. The market consensus that the economy will contract is considered in the Macro Commentary section below. The treasury secretary also indicated issuance will continue at the short end of the curve rather than long bonds as the market was expecting with Trump. This will reduce the number of long bond auctions. As a result, the 3m-10 yr yield curve has inverted, however this may also reflect a pause in the Feds rate cutting. US 10 yr. treasuries fell to 4.20%.
Australian bond yields broadly tracked changes in US yields, ignoring the increasingly frightening spending promises being made by the government ahead of an election that is now expected to be called on in the short term for a 12th of April election day. 10 yr comm. Gov. bonds fell by 0.15% to 4.30%.
Major Credit Markets
US investment grade (IG) markets were weaker with economic data casting doubts on corporate profits. IG company balance sheet fundamentals however are still very strong, reflected by the huge primary issuance, February being the second highest issuance month ever.
Despite some widening of the Aust. iTraxx, new issuance activity picked up last week with final pricing indicating strong demand. Liberty priced a new $300m5 year at +205bps, the tightest margin the issuer has ever achieved. For perspective we first bought Liberty Senior on a margin of 350bps. NBN priced $750 10-year at +115bps. Banco Santander issued $350m 10NC5 Tier 2 at +192bps despite its prospective CFO being investigated by Argentinian regulators. IAG issued $700m 12.3NC7.3 Tier 2 at the very tight at +168bps. Needless to say, none of these bonds were purchased by our mandates. We are watching the smaller book builds on these types of issues in Europe as an early signal that margins will widen from here.
High Yield Markets
The US high yield market finally succumbed to market volatility and weak economic data with HY spreads significantly widening by on average 0.20% for the week. However, as we have commented for some time now, HY spreads have been at long term lows and were due for a correction. Monies still flowed strongly into HY funds, but this is likely to reverse if volatility continues and will cause HY spreads to widen further.
The hybrid market firmed over the week as investors sought a range of major bank hybrids about to go “ex-div”. Those that did go ex-dividend during the week held the franking credit value, this resulted in some trading at too skinny margins. For example, CGFPC fell from a margin cum-dividend of 2.45% to under 2% ex-dividend. Overall hybrid volumes were elevated well above average levels. NAB and Westpac hybrids dominated the turnover with NABPH trading near $10m for the week.
Listed Hybrid Markets
Hybrid fair value to Investment grade credit
We often look at hybrids fair value vs. the iTraxx index, a measure of the top 25 Aust. corporate senior bonds margins. A simple ratio of the average major bank hybrid margin to the iTraxx index reveals relative value. The chart below goes back to 2013. The average level since that time is shown (green line). Peaks in the ratio signal hybrid margins high relative to Investment grade credit. Troughs the opposite. Currently hybrids look slightly expensive over this long timeframe (i.e. last ratio compared to green line). However, looking at the recent period since June 2022, when cash rates were rising strongly (as shown by the red line), hybrids look slightly cheap. Given the recent APRA changes have taken some risk out of their repayment probability, comparison to this shorter timeframe has good merit. On this basis hybrids now look good value, not screamingly cheap but definitely not expensive as in 2023.
Forward Interest Indicators
Australian rates
Swap-rates post large falls with bond rates.
Swap rates:
- 10-year swap 4.28%
- 7-year swap 4.11%
- 5-year swap 3.97%
- 1-month BBSW 4.09%
