Succumbing to politics, stimulus talks done

Politics continues to dominate market chatter. There were two big developments last week.  First, and most importantly for the here and now, Senator McConnell dismissed the Senate, signalling that stimulus talks are completely done for now.

While senators were told to prepare to return to Washington, D.C. with 24 hours notice, the next three weeks bring National Conventions and then the Labor Day holiday. The next stimulus bill looks like a September affair, perhaps coinciding with the budget negotiations due by the end of that month.

This will likely be a drag on the recovery, hurting spending by lower income households especially.  Indeed, last week’s retail sales report showed a higher total level of spending than in February, pre-COVID, a heavy portion of that due to the generous stimulus checks from D.C. that are not currently flowing to households.

Does Biden VP pick signal middle-of-the-road campaign?

Former Vice President Biden chose the junior senator from California, Kamala Harris, as his running mate. This was not a surprise, as she was leading in the betting markets. But it appears to signal Biden’s intention to run a middle of the road campaign. Still, it remains too early for markets to move substantially ahead of this coming election. We think the Labor Day holiday, or perhaps the first Presidential debate at the end of September, will be the dividing line.

Bonds anything but quiet last week

If equities were quiet last week, bonds, at least by recent standards, were anything but! Yields shot higher for the second week in a row. While the U.S. 2-year yield rose only 2 basis points (bps) — again, the Fed isn’t hiking anytime soon — the 10-year and 30-year yields rose 15 and 21 bps, respectively. That’s the biggest weekly increase in the 30-year yield since early June.

While that early June increase in interest rates was driven by reopening/reflation optimism, this recent price action is much more prosaic in nature. In our view, interest rates have backed up due to the massive issuance at the long-end of the yield curve coupled with the low liquidity of August. Thursday’s record 30-year auction — $26 billion in bonds — was sloppy and the curve may need to steepen further in the short term to digest the coming supply. But foreign demand remains strong, and U.S. rates are higher than other government yields across the globe.

Credit spreads widened, investment-grade (IG) up 3 bps and high-yield (HY) up 19 bps, which was a bit of a surprise given the positive equity market price action and general quiet issuance calendar.

Economic data broadly positive, pace of gains slows

Economic data has been broadly positive, although the pace of gains is clearly slowing. China versus U.S. retail sales, both reported last Friday, provides an interesting case study. In China, retail sales are still lower than they were a year ago, despite a strong COVID-19 response, while U.S. retail sales are at record highs. To us, that shows just how important the government transfer payments have been, and continue to be, to the U.S. recovery.