Weekly Fixed Income Commentary (March 2, 2023)
Corporate bond market commentary
- IG credit spreads widened 2 bps WoW to 123 bps, while yields jumped another 18 bps to 5.5% and are now higher on the year after climbing 70 bps off the YTD lows. This resulted in total return of -1.0% WoW, extending the losses since February 2 to -4.3%
- IG fund flows accelerated to $4.5 billion in inflows, extending the string of inflows to eight weeks – the longest such stretch since October 2021.
- HY credit spreads tightened 8 bps this past week to 419 bps even as yields rose another 11 bps to 8.7%, nearly a 100-bp swing off the lows in early February. Total return was down -0.2% WoW, extending recent losses to -3.3% and leaving YTD total return at 2.0%. Total return performance across ratings were mostly uniform this past week, with modest underperformance by CCCs (-0.3% WoW) versus slight outperformance by single-Bs (-0.1%).
- HY fund flows surged to $6.5 billion in outflows, the largest outflow since the Covid-19 driven exodus in March 2020. New issuance was zero, leaving year-to-date supply -4%.
- In HY, dealer inventory increased $1.2 billion to $4.2 billion, the largest net long since November 2021, as dealers added positions throughout the curve.
Our take: The large rate move has pushed all-in yields on higher quality corporate credit to more attractive levels, as the IG market is north of 5.5%, BB High Yield is 7.13% and overall HY is approaching 9%. BB yields have spent very little time above 8% over the last 20 years aside from late ’08 into late ’09 and a brief spike during the March ’20 virus sell-off. Dealer inventories are elevated, which is a bit of a headwind, and cash balances are slightly lower, so starting to nibble on more bonds at these levels makes sense, with a bigger bite coming if there is either more of a flush and/or some rate stability.
Economic commentary
- Durable goods orders fell 4.5% in January, even more than expected, but the weakness was entirely in a 54.6% drop in civilian aircraft, which followed a 105.6% rise in December. Under the surface, nondefense capital goods orders ex-aircraft, the core orders feeding into GDP, rose 1.1%, more than reversing declines in November and December. Still, they were not up enough to recover to August levels. Since then, core durable orders and shipments have moved sideways.
- PCE core deflator rose 5.4% YoY versus an expectation of 5.0% and the prior month’s revised 5.3% and ISM prices paid increased to 51.3 from 44.5 last month and a consensus estimate of 46.5. Both are further data points of price pressures re-accelerating.
Our take: General improvement in the fourth quarter of last year perhaps gave false hopes the worst inflationary pressures were in the past. Even if January data are revised downward or followed by improvements this spring, only a couple months of data going back to late 2021 show monthly increases consistent with the Fed’s long-run 2% target. For the Fed to feel inflation is under control, the momentum needs to be persistently slower. The next FOMC meeting is March 22. In addition to an additional rate increase of 25 or perhaps even 50bps, revised dot plots will be released. If February retail sales and CPI look like January’s, watch for the 2023 dots to rise in the updated dot plot and expect a more hawkish tone from Powell.
Municipal bond market commentary
- Last week high-grade tax-exempt bonds outperformed Treasuries by 2, 3, and 2 bps in the 2-, 5-, and 10-year maturities and underperformed by 2 bps in the 30-year maturity. AAA Muni/Treasury ratios ended the week at 61%, 62%, 66% and 91% and AA Muni/Corporate ratios finished at 60% in 2 and 5 years, 59% in 10 years, and 82% in 30 years.
- For the period ending February 22nd, tax-exempt funds reported outflows of $1.7 billion, consisting of $1.3 billion of outflows from open-end funds and $368 million of outflows from ETFs.
- Municipal Bid Wanted volume reported by Bloomberg totaled $4.69 billion for the holiday-shortened week.
- The new issue calendar this week totals only $5.3 billion. Long-term visible supply over the next 30 days is projected at only $9.6 billion and reinvestment from interest payments, maturities and redemptions is projected at $14.9 billion, implying negative net supply of $5.3 billion.
Our take: AAA tax-exempt yields are now basically unchanged since the start of the year, with the negative returns of February offsetting more than 70% of January’s positive returns. The municipal market weakness in February was driven largely by the direction of the Treasury market in its reactions to economic data and expectation of a persistent hawkish Fed policy for a longer than hoped-for period of time. Despite the extreme richness at the shorter end of the municipal yield curve, individual retail investors continue to be attracted to the higher level of absolute yields. For example, high-grade yields in 2 years are currently 2.93%, which is 189 bps higher than a year ago.. While fund outflows have recently picked up, we understand that institutional investors (that pay more attention to relative value) still have plenty of available cash but are awaiting a better entry point to put it to work. A weaker technical picture in March may very well present such an opportunity. As we entered February, reinvestment dollars exceeded projected new issue supply by $16.3 billion, much larger than the $5.3 billion estimated difference for March. Without the relatively positive supply/demand environment, February municipal performance might have been worse. We anticipate more weakness in March and April but view that as an opportunity.
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