DECEMBER 11, 2023

The $422 million December debenture offering was sizable given the relatively short processing window and the overall backdrop in low origination/issuance activity in other lending spaces. For calendar year 2023, $5.1 billion in 504 debentures were issued. While that figure is fully $2 billion lower from the (perhaps unassailable) 2022 record, it is over $1 billion above the average of the three years before the pandemic.

Sharp m/m drop in debenture rates. CDC’s benefited from a sharp m/m drop in the debenture rates of 41 bps and 43 bps, respectively, for the 20- and 25-year maturities (rates were 5.23% and 5.28%). This is the third time in this now 45-month bear market in bonds the 504 debenture rates fell over 40 bps m/m. The prior two drops were followed by a quick resumption in the uptrend in interest rates. We must remember, this remains a bear market that no active fixed income professional has experienced.

Let’s take these m/m debenture rates drops when we can get them! Another nice note is that debenture rates now have fallen for two consecutive months, something not seen since Jul-Aug 2022.

Another “front run” attempt. The sharp drop in debenture rates from November resulted from yet another attempt by the market to push back against the Fed’s policy stance, i.e. front run the Fed. Fed leadership keeps talking Fed policy rates staying at least as high as currently and for longer. Another rate rise is on the table according to them. But the market has (again) moved forward the expected timing of the first rate cut of the next easing cycle. Back in October, using money market futures prices, the market priced a first rate cut well into the second half of 2024. Recently market pricing has that first cut moved up into the spring of 2024.

Driving the market optimism is a turndown in the economic surprise index, seen in the chart below (blue line). This downturn tells us that actual economic data results had been well above forecast but now are only a bit above forecast. In other words, the economy is doing better than expected, but not by so much, the soft landing may be upon us. Thus, the market concludes, the Fed’s work tightening is done and policy rates, in fact, may be too restrictive and eventually slow the economy too much. Therefore, the Fed will have to cut rates sooner than leadership has signaled. If that’s the case then let’s jump ahead of the Fed and buy bonds! That’s been the market response.

Who’s right? Will the Fed view or the market view be right this time? Face it, no one - Fed, individual or market - can consistently predict economic or interest rate directions. That is the only thing we know with certainty. So it remains to be seen which view prevails. This tug of war is age-old. For example, as our annotated 10-year T-note yield chart below shows, the market has now tried to clearly front run the Fed way three times in this bear cycle. We can see the market lost the first two tries as rates resumed the uptrend after the first two attempts. It remains to be seen for this third try whether the bear cycle peak is in place. Hope springs eternal.

In the meantime, let’s enjoy the benefit of the recent sharp drop in debenture rates, some good news in a historically strong bear market in bonds. Eventually the market will get the bet mainly correct, the Fed tightening will be done, and the bear cycle will end offering a chance for a further correction lower in interest rates. But no one will quite know exactly when. Maybe this time?

SOURCE; EAGLE COMPLIANCE, LLC