Intro

Hello, I’m Javier Lopez, Fixed Income Specialist, and part of the investment committee at Axxets Wealth Management.

For the last 18 months, we witnessed the most aggressive Fed’s hiking cycle in the last 4 decades; with an increase of 525 bps to the Federal Funds Rate divided into only 11 hikes.

Now, the landscape has changed, as we are at, or very close to the end of this cycle. As a result, the market is expecting rate cuts for the next 24 months, although at different paces along the yield curve. For example, expectations aim to a 70-bps cut of the Fed Funds rate by 2Q24, while a 113-bps cut for the 2Y Yld is expected for the same period.

As the forecasted Yield curve is expected to shift downwards, the Reinvestment Risk arises.

What is Reinvestment Risk? BANNER QUE SALGA CON ESTA PREGUNTA

Reinvestment risk is the potential that the investor will be unable to reinvest cash flows at a better or same rate to their current rate of return, creating an opportunity cost. In other words, is the potential that the cash flows received each following period would be less than the previous ones.

Let’s put it like this:

Imagine you are about to invest 1MM for 3 years and you have two options:

1. Invest your money for 1y in a zero-coupon bond (bond with no interest payments before maturity). And reinvest it for another year until year 3. Rates for year 1, 2 and 3 are 5%, 4% and 3% respectively.
2. Invest in a 3y zero-coupon bond at a fixed rate of 5%.

The opportunity cost, or difference of investing under the 1^st option is roughly $33,000 or 3%.

Poner la tabla que haga pop-up

As we speak, the 1Y expected rates for the next 5y, signal a clear downtrend from 5.38% to 3.63%, around 175-bps difference. BANNER QUE SALGA LA GRÁFICA DE TASAS

How can we mitigate this risk? BANNER QUE SALGA CON ESTA PREGUNTA

We consider that IG is an attractive sector to be exposed to as it will help lock in decade-high ylds that will be even more appealing as interest rates go down during the next 12m. Especially in maturity bands between 5-10 years where the difference of BBB-rated corporate bonds with Treasuries range between 120 and 160 bps.

Final remarks

• With expectations of lower rates, reinvestment risk becomes significant
• But, there are way to mitigate it, for example, IG corporate bonds offer attractive rates in tenors between 5-10y that will help lock-in decade high ylds.

Hello, I’m Javier López, Fixed Income Specialist @ Axxets Wealth Management.

With interest rates on multidecade highs and fixed income expected to show interesting returns in the short/mid-term. We deem it important to explain how bonds work, as this is a $130 trillion market vs the $109 tn market for equities.

What are bonds?

In a nutshell, when you buy bonds, you’re providing a loan to the bond issuer, who has agreed to pay you interest and return your money on a specific date in the future.

Companies sell bonds to finance ongoing operations, new projects, or acquisitions. Governments sell bonds for funding purposes, and to supplement revenue from taxes. When you invest in a bond, you are a debtholder for the entity that is issuing the bond.

Bonds, especially investment grade, can help hedge the risk of more volatile investments like stocks, as they stand higher in a company’s capital structure.

Key terms for understanding bonds

• Maturity: The date on which the bond issuer returns the money lent to them.
  
  
• Face value: Is the amount your bond will be worth at maturity. A bond’s face value is also the basis for calculating interest payment. Most commonly bonds have a par value of $1,000.
  
  
• Coupon: The fixed rate of interest that the bond issuer pays its bondholders on an annual basis. Using the $1,000 example, if a bond has a 3% coupon, the bond issuer promises to pay investors $30 per year until the bond’s maturity date. The higher the coupon, the higher the credit risk the bond is exposed to.
  
  
• Yield: The rate of return on the bond. While coupon is fixed, yield is variable and depends on a bond’s price in the secondary market and other factors.
  
  
• Price: In the market, bonds have two prices: bid and ask. The bid price is the highest amount a buyer is willing to pay for a bond, while ask price is the lowest price offered by a seller. The price is shown as a % of the Face Value.
  
  
• Duration risk: This is a measure of the sensitivity of the price of a bond as yields fluctuate. There is an inverse relationship, if yields go up, prices go down. The longer a bond’s duration, the higher exposure its price has to changes in interest rates.
  
  
• Rating: Ratings agencies, like S&P, Moody’s and Fitch, assign ratings to bonds and bond issuers, based on their creditworthiness. This is: how well companies or sovereigns are positioned to timely fulfill their financial obligations. Bond ratings help investors understand the risk of investing in bonds.

Stay to learn more about the types of bonds, and how they are priced. And remember that, at Axxets, our greatest interest is you.

Hello again Mr. Bond (Pt. 2)

Hi, I’m Javier Lopez, fixed income specialist at Axxets Wealth Management. In our previous clip we defined what bonds are and their key terms. Making this clear, let’s move on to the types of bonds and the factors that affect their price.

Bond Features

We can further classify bonds according to the way they pay interest and certain other features:

• Zero-Coupon Bonds: As their name suggests, do not make periodic interest payments. Instead, investors buy zero-coupon bonds at a discount to their face value and are repaid the full face value at maturity. Treasury bills and CETES in México are Zero-coupon bonds.
  
  
• Callable Bonds: These bonds let the issuer pay off the debt—or “call the bond”—before the maturity date. Call provisions are agreed to before the bond is issued.
  
  
• Puttable Bonds: Investors have the option to redeem a puttable bond—also known as a put bond—earlier than the maturity date. Put bonds can offer single or several different dates for early redemption.
  
  
• Convertible Bonds: These corporate bonds may be converted into shares of the issuing company’s stock prior to maturity.

How are bonds priced?

Bonds are priced based on their face value, or par. Bonds that are priced above par are said to trade at a premium, while bonds that are priced below their face value trade at a discount. Like any other asset, bond prices depend on supply and demand. But credit ratings, market interest rates and other macro variables play big roles in pricing, too.

Therefore, investors should work with their financial advisor to help select bonds that provide income, tax advantages and features that make the most sense for their financial goals.

Wrapping up

• Bonds are investment securities where an investor lends money to a company or a government for a set period of time, in exchange for regular interest payments as well as repayment of principal at maturity.
• The price of a bond is influenced by the issuer’s creditworthiness, as well as market developments, such as interest rate dynamics.
• Fixed-income investments should be a core part of your investing strategy, as bonds can provide both stability and predictable income.
• Therefore, investors should work with their financial advisor to help select bonds that provide income, tax advantages and features that make the most sense for their financial goals.

In Axxets, our greatest interest is you.

Each year, Congress must pass legislation to fund the federal government for the next fiscal year. A shutdown occurs if Congress is unable to pass the necessary spending bills, or a resolution providing interim funding before October 1, when the fiscal year begins. In this context, the Senate passed a last-minute spending bill, avoiding a government shutdown. This bill allows the government to remain open for 45 days (until November 17), giving Congress more time to complete this funding process in the midst of arduous negotiations. It is important to note that issues related to border security and aid to Ukraine were the two major points that delayed an agreement. Below, we share some of the economic implications of a potential government shutdown.

• A shutdown would affect federal agencies that rely on discretionary spending.  Not all government spending would be affected by a shutdown. Congress passes annual funding bills to fund discretionary spending (defense programs, education, transportation, etc.). In total, these expenditures account for 25% to 30% of federal spending. Mandatory spending, such as Social Security, Medicare or interest payments, is regulated by other laws and would not be affected by a lack of appropriations. In addition, not all funding shortfalls affect the entire discretionary budget. During some previous shutdowns, Congress passed one or more of the 12 appropriations acts, limiting the scope of those shutdowns to only those agencies whose funding had expired.
• A shutdown would primarily affect the economy through three channels. First, there would be a loss of productivity due to furloughed federal workers. When a government shutdown occurs, a portion of federal workers are furloughed, meaning they are temporarily not allowed to work, which affects the normal functioning of the government. Second, there would be a negative impact from delayed payments to businesses, contractors and employees. However, it is likely that any postponed spending would be realized once the government resumes operations, while delayed salaries would be retroactively compensated. Finally, a shutdown could disrupt the delivery of government services to the private sector such as: delays in permitting, licensing, federal loan processing, disruption in tourism (closures of museums, parks, monuments, etc.) and transportation.
• In general, a government shutdown affects the economy to the extent that it is prolonged. In this regard, there have been 20 such episodes since 1976, with an average duration of eight days. The longest shutdown, which occurred in 2018-19, lasted for 34 days.

Are financial markets worried about government shutdowns? In reality, the historical average performance of the S&P 500 during government shutdowns has been slightly positive, averaging around 0.1%, which is virtually neutral. However, these are events that do have the potential to generate very short-term volatility. In the 2018-2019 government shutdown, the S&P 500 fell 2.7% on the first trading day after the shutdown, recovered nearly 5% on the next trading day, and was up over 10% by the end of the 34-day shutdown. Broadly speaking, investors view this as a temporary event, which translates into a modest impact to the economy. That said, the Congressional Budget Office estimated that the 2018-2019 shutdown cost the economy about US$3bn.

List of the longest government shutdowns in U.S. history

Note: start dates are the final dates of the budget authority, where funding shortfalls began the following day.

Source: morningstar, Charles Schwab y nytimes

The quarterly earnings season will begin in the coming weeks. Overall, the consensus estimates an annual decline (YoY) of -0.2% for S&P 500 companies’ earnings during the third quarter. If these expectations are confirmed, this could represent the fourth consecutive quarter in which the index reports a decline in earnings. However, this could also mark the smallest YoY decline during this streak.

On a positive note, analysts have so far lowered their 3Q23 earnings estimates by a margin below historical average. In this context, 3Q23 earnings forecasts have only been adjusted down by 0.2% since June 30. This decrease is lower than the 5-year and 10-year historical averages, which reflect negative revisions of 3.6% and 3.4%, respectively.

Eight of the eleven sectors are projected to report YoY earnings growth, led by the Communication Services (+32.1%) and Consumer Discretionary (+21.6%) sectors. In contrast, the Energy (-39.6%) and Materials (-22.0%) sectors are expected to experience the most significant declines, primarily due to lower average oil prices (down approximately 11% compared to 3Q22) and other commodity-related factors. Excluding the drop in the energy sector, earnings for the entire S&P 500 would grow 5.3% YoY.

On the sales side, 2023 YoY growth of 1.5% is anticipated, which is below the 5-year average revenue growth of 7.7% and below the 10-year average revenue growth of 5.0%. Should this figure be confirmed, sales would have posted the eleventh consecutive quarter of growth.

Finally, with this mix of factors, the profit margin (net income / total revenues in %) of the companies would stand at 11.7%, which implies a contraction of 20bp compared to the 3Q22 margin. Encouragingly, this margin level exceeds the 11.4% average of the last 5 years.

With JP Morgan sounding the starting signal on October 13, investors will closely monitor the season’s progress, especially in light of the resilient earnings performance observed thus far despite a tight monetary environment, in which inflation is still in the process of decreasing and consumption is decelerating.

S&P 500: expected earnings growth for 3Q23

Source: FacSet

As expected, the FED kept the reference rate target range unchanged at 5.25 – 5.50%, the highest level in 22 years. This decision was unanimous. The statement revealed language very similar to that of July, confirming that in determining the degree of additional monetary policy tightening that may be appropriate to eventually bring inflation back to 2%, the Committee will take into account all the measures that have been implemented so far, the lags with which monetary policy affects economic activity and inflation, as well as the development of economic and financial factors. It will also continue to evaluate additional information as it emerges and its implications. Within the economic outlook, he noted that recent indicators suggest that activity has been expanding at a solid pace. Although employment gains have decelerated in recent months, it continues to show solid performance, while the unemployment rate has remained low. Inflation, however, remains elevated.

On the other hand, the FED updated its macroeconomic forecasts. In this context, it stated that the federal funds rate could end the year at 5.6%, unchanged compared to the June estimate. This level implies that an additional increase of 25bp would be needed, which could occur during the remainder of the year (November or December meeting). Regarding 2024, the new expectations imply a more restrictive scenario, suggesting that rates will remain high for longer, after raising the rate estimate to 5.1% from the 4.6% forecast in June.

Regarding the economic outlook, GDP could close this year with a growth of 2.1%, substantially higher than the 1% estimate of June. Likewise, for 2024 they forecast an expansion of 1.5% (vs. 1% forecast in June). On the other hand, they positively adjusted the unemployment rate, such that it could close this year at 3.8% from 4.1% and remain above that level in 2024 (vs. 4.5% previously forecast). Finally, core personal consumption inflation (core PCE) would improve to 3.7% from 3.9% previously forecast for the end of this year. Meanwhile, by 2024 there would be a significant improvement, which could bring it to 2.6% (unchanged vs. June’s forecast).

During his press conference, Jerome Powell emphasized that the Committee is prepared to tighten conditions further if necessary. However, they will continue to make decisions on a meeting-by-meeting basis, taking into account all the information that becomes available, and evaluating the implications that this could have on economic activity and inflation.

FED Indicators Update (September vs. June)

Source: Federal Reserve 

The consumer price index accelerated by 0.6% monthly in August, surpassing expectations of 0.6% and the 0.2% recorded in July. This marked its largest advance in 2023. Consequently, annual inflation reached 3.7%, exceeding the expected 3.6% and the 3.2% observed in July.

On the other hand, core CPI inflation, which excludes volatile components such as food and energy, increased by 0.3% in August, surpassing the expected 0.2%. Its annual change stood at 4.3%, in line with expectations but lower than the 4.7% reported in July. This component comprises approximately 80% of the entire index, highlighting its significance in the Federal Reserve’s monitoring efforts.

When breaking down the figures, the gasoline index contributed the most to the monthly increase in all items, accounting for over half of the overall rise. Gasoline prices surged by 10.6% in the month (declining by 3.3% annually). Overall, the energy category saw a monthly increase of 5.6% (with an annual decrease of 3.6%). However, these pressures in gasoline and energy are expected to be temporary.

Meanwhile, the continuous rise in the shelter index continued to exert pressure, marking 40 consecutive months of increases. The shelter index increased by 0.3% during the month (and 7.3% annually). The food index exhibited a 0.2% increase (4.3% annually), with the food at home category rising by 0.2% monthly (3% annually) and food away from home increasing by 0.3% monthly (6.5% annually). Additionally, the report showed that airfares increased by 4.9% in the month but decreased by 13.3% annually. Used vehicle prices, which significantly contributed to inflation in 2021 and 2022, declined by 1.2% in the month and registered a 6.6% annual decline. Transportation services increased by 2% in the month, with an annual increase of 10.3%.In summary, the numbers present a mixed but somewhat neutral outlook for the Federal Reserve’s next decision (consensus discounts as a fact that there will be no rate hike next week). It is evident that inflation is declining from its peak of approximately 9% annually in June 2022, the highest since November 1981. However, there is still room for improvement as core CPI remains elevated due to pressures in shelter, while employment indicators continue to show strength.

CPI monthly change (%) over the last twelve months

Source: U.S. Bureau of Labor Statistics

Change (%) in the last twelve months in CPI and Core CPI

Source: U.S. Bureau of Labor Statistics

Labor market figures continued to reflect a broadly robust outlook during August. Nonfarm payrolls advanced by 187,000 jobs (compared to the expected 170,000) and represented an acceleration from the previous month’s downwardly revised 157,000 job increase. This increase would have been even larger if not for the Hollywood strike. The August increase was once again led by the health care and social assistance sector, adding another 97,000 jobs. Additionally, the leisure and hospitality sector stood out with the creation of 40,000 jobs. In contrast, transportation and warehousing activities accounted for the loss of 34,000 jobs.

Another significant fact was that the participation rate, which is the percentage of the population that is working or actively seeking employment, climbed by two-tenths of a percentage point to 62.8%, reaching a post-pandemic high. This increase in the participation rate was led by the younger segment of the population. To a greater extent, this situation caused the unemployment rate to rise by three-tenths to 3.8% (compared to the expected 3.5%), the highest since February 2022. On the other hand, it was noted that the number of unemployed increased by 514,000 to 6.4 million people.

Meanwhile, average hourly wages rose by just 0.2% in the month, leading to a deceleration in annual growth to 4.3% from 4.4%. Finally, job openings and labor turnover survey (JOLTS) fell in July to 8.83 million (compared to 9.17 million in June), marking the weakest figure since March 2021 and the third consecutive decline.

Having analyzed this labor market data and awaiting the release of August’s inflation data in a week (the consensus estimates that core inflation will reach an annual rate of 4.3% compared to 4.7% in July), the market is beginning to anticipate that the Fed could have arguments to implement a pause in its next monetary policy meeting on September 20. The consensus assigns a 93% probability that the reference rate will remain at its current levels of 5.25% to 5.5%.

Nonfarm payroll (Change during the month, in thousands)

Source:  JP Morgan

Official Unemployment Rate including part-time and discouraged workers (monthly in %)

Source:  JP Morgan

Measured in dollars, net private wealth declined by US$11.3 trillion (tn) to US$454.4tn by the end of 2022 (-2.4% annually). This marked the first decline in global wealth since 2008. Wealth per adult also declined by 3.6% annually to US$84,718, with much of this decline attributed to the appreciation of the U.S. dollar against many other currencies. On a constant exchange rate basis—meaning, isolating the effects of exchange rate fluctuations—total wealth and wealth per adult would have grown by 3.4% and 2.2%, respectively. These figures represent the lowest increase in wealth at constant exchange rates since 2008. Applying the same exchange rate analysis and considering the effects of inflation, the result reflects a real wealth loss of 2.6% in 2022. In detail, financial assets contributed most to the decline in wealth last year, while non-financial assets (mainly real estate) remained resilient, despite the accelerated increase in interest rates.

In terms of regional performance, the global wealth loss was concentrated largely in wealthier areas such as North America and Europe, which together lost US$10.9tn. Meanwhile, the Asia Pacific region recorded losses of US$2.1tn, while Latin America was an outlier, with a total increase of US$2.4tn, driven by an average exchange rate appreciation of 6% against the US dollar. The United States led the list of losses in 2022, losing US$5.9tn, in comparison to a US$19.5tn increase the previous year. This marked the first break in a remarkable sequence of gains dating back to the 2008 global financial crisis. Japan, China, Canada, and Australia similarly posted losses of more than US$1tn. On the other end of the spectrum, the largest wealth gains were recorded in Russia, Mexico, India, and Brazil. In terms of wealth per adult, Switzerland continued to lead the list with US$685,230, followed by the United States with US$551,350, and Hong Kong with US$551,190.

By demographics, the non-Hispanic Caucasian population in the U.S. saw their wealth decline by approximately 4.5%, while the African-American population emerged from the recession almost unscathed. Additionally, Hispanics achieved a 9.5% increase in wealth, owing to their higher holdings of real estate assets compared to financial assets.

The increase in wealth inequality during the pandemic reversed in 2022. The share of wealth owned by the world’s richest 1% experienced a reduction, although it remained slightly above the 2019 level. Despite this segment owning approximately 46% of total global wealth, global wealth inequality has decreased in this century due to faster growth achieved in emerging markets, especially in China. Other figures suggest that the world’s highest net worth individuals in dollar terms fell by 3.5 million over the past year to 59.4 million. Lastly, the ultra-high net worth (UHNW) group with wealth above US$50 million saw a decrease of 22,490 members. North America accounted for 81% of this decline.

Projections indicate that global wealth will increase by 38% in the next five years, reaching US$629tn in 2027, driven by the growth of middle-income countries. Conversely, wealth per adult could reach US$110,270 in 2027, and the number of the wealthiest individuals could reach 86 million, while the number of UHNW individuals could rise to 372,000 (currently at 243,060 individuals).

Annual change (%) in real global household wealth and its components

* The graph was assembled using smoothed exchange rates.

Source:  UBS

Change in household wealth by region in 2022

Source:  UBS

This will be Jerome Powell’s sixth speech at the Jackson Hole Economic Symposium, noting that his most recent addresses have varied considerably in length and tone. In 2020, Powell introduced the contested concept of “average inflation targeting,” whereby, after periods in which inflation had been below 2%, the appropriate policy would aim to achieve inflation slightly above 2% for some time. A year later, he noted higher inflation and argued that these higher readings were likely to be temporary. Last year at this time, however, he radically changed his tone, communicating a tough message about the challenges posed by inflation and an absolute determination to bring it down. Such restrictive rhetoric may be repeated to some extent this week, as a more balanced assessment is also not ruled out, highlighting on the one hand the progress the economy has made in achieving a deceleration of inflation, and on the other hand, the risks that could eventually arise as a result of fighting this arduous battle.

Regarding inflation, Powell will have positive news to report over the past year. Inflation currently stands at 3.2% annually (vs. 9% on June 22), although upcoming figures could show a momentary rebound expected in gasoline during August. Food prices are also likely to remain under pressure, in line with international prices. On the upside, there continues to be evidence that rental costs and the new vehicle market continue to decelerate.

On the other hand, a balanced view of the labor market would consider the ongoing gradual normalization, with the unemployment rate at 3.5%, near a 70-year low, while nonfarm payrolls added more than 3.3 million jobs last year. Job offers remain well above pre-pandemic levels with nearly 9.6 million job vacancies. However, vacancies are down from their peak of more than 12 million in March 2022 and the pace of job creation is slowing, with only a 187,000 increase in July nonfarm payrolls. Another crucial point relates to wage increases, which while strong over an annual rate of 4.4% (vs. 4% historically), are arguably not overly robust, reflecting more of a compensation for past inflation rather than the result of an intensely competitive labor market.

Finally, a balanced view would probably consider that the current surge in the economy could be temporary. In this regard, economic performance appears robust, with annualized growth of 2.0% and 2.4% in the 1Q23 and the 2Q23 GDP, respectively, despite a tight financial environment, the culmination of pandemic-related economic supports, and a mini banking crisis earlier in the year. Looking ahead, the economy is anticipated to experience reduced momentum due to higher interest rates, potentially impacting the dynamism of the real estate sector, as well as overall investment and consumption. In summary, since the last Jackson Hole conference, a significant improvement in the U.S. economy has been observed. In this context, Powell must acknowledge that the current resilience may not be assured in the upcoming months. Therefore, an anticipated balanced discourse, considering these factors and emerging data, is crucial.

Annual change (%) in headline inflation components

*In July, inflation stood at 3.2% annually.

Source:  JP Morgan

With ~97% of the votes counted, the big surprise of these primary elections known as PASO (Simultaneous and Mandatory Open Primary Elections) was the result obtained by the party La Libertad Avanza, reflecting the immense discontent among Argentine society towards the constant failures of traditional politicians, highlighted by an annual inflation currently around 116% and statistics that show 4 out of 10 people living in poverty.

Within this context, Javier Milei was the winner with about 30.3% of the votes (vs. the 19.3% average suggested by the last polls). In second place was Macrismo through its coalition Juntos por el Cambio (Patricia Bullrich), with 28% of the votes, and finally, the ruling Peronist-Kirchnerist representation (Sergio Massa), Unión por la Patria, registered 27%. In this sense, Javier Milei was the most-voted candidate in 16 of the 24 provinces, with an outstanding performance in Córdoba, Santa Fe, and Mendoza. Considered a libertarian, Javier Milei is an economist born in the city of Buenos Aires, with a political career that has transcended for his controversial statements against different political and social aspects (e.g.: the disappearance of the Central Bank, dollarization of the economy and legalization of the organ sale market).

On the other hand, the participation rate stood out at 69.5% (vs. 67% in 2021, which represented a minimum, probably affected by Covid-19); nevertheless, it still prevailed well below the historical average of the primaries at 77% and implied the lowest reading for a presidential election. According to specialists, the low turnout could offer the traditional coalitions room to grow in the following months.

After the conclusion of the PASO, the candidates of the alliances that will participate in the presidential election of next October 22 were defined. This election will be key because the winner will have to find solutions to a number of challenges such as the crisis weighing on Argentina’s agricultural sector (one of the world’s main exporters of soy, corn, and meat), constant episodes of volatility in the financial markets, and maintaining talks with the IMF given the recent US$44bn debt agreement.

Argentine Primaries: 3 way split

Source:  Reuters