Weekly Fixed Income Commentary (March 9, 2023)
Corporate Bond Market Commentary
- IG credit spreads tightened 3 bps WoW to 120 bps and yields declined 2 bps to 5.5%, resulting in excess return of +24 bps and total return of 0.4%. This capped a three week stretch of losses that left excess return down -65 bps and total return down -4.3% over that period.
- HY credit spreads narrowed 22 bps WoW this past week to 397 bps, while yields declined 16 bps to 8.6%. This resulted in a total return of 0.8% WoW, retracing more than a third of the losses in the prior three weeks and leaving YTD total return to 2.8%. Across ratings, CCCs outperformed on a total return and generated 1.3% WoW versus 0.8% for single-Bs and 0.7% for BBs, leaving YTD total return at 6.8%, 3.1% and 1.7%, respectively.
- US IG recorded $5.0 billion in inflows, its largest inflow in seven weeks, while redemptions moderated in leveraged finance, with US HY and leveraged loans reporting outflows of $2.1 billion and $0.1 billion, respectively.
- Supply remained strong across the board, led by US IG (+$52.8 billion) and US HY (+$7.0 billion).
- As of the prior week, dealers reduced their net long inventory in US IG by $0.9 billion to $3.4 billion and trimmed their net long in US HY by $1.1 billion to $3.0 billion.
Our take: Last week saw a bounce after a few rough weeks of losses. However, with continued tough talk from the Fed ahead of the quiet period, bonds have sold off again so far in the current week. Until we get more stability in rates, we would expect HY to be somewhat volatile within a trading range, and we are happy to clip the coupons on these attractive all-in yields during this period and trade around the volatility. Eventually, the economic repercussions from all of this tightening will be felt on borrowers at the lower end of the credit spectrum, and we continue to favor up-in-quality for the resiliency of these companies during an eventual recession.
Economic Commentary
- Traders listened closely to a number of Fed speakers before the quiet period in advance of the FOMC meeting later this month. In general, the messages indicate greater inflation concerns and the likelihood for the potential need for higher rates for a longer period of time before any pivot to easing can begin. At this writing, the Implied Fed Funds Futures imply a terminal rate of approximately 5.60% in mid-year 2023.
- The ISM manufacturing and services numbers also evidenced an overall continuing pace of growth in the economy.
- Wednesday’s JOLTS Report showed small improvement from a revised 11.234 million in December to 10.824 million for January but were higher than estimates of 10.546 million, and this continued tightness in the labor market adds support for hawkish Fed policy.
- Beyond the United States, inflationary pressures are growing globally. Reports last week showed that German inflation unexpectedly accelerated following similar news from France and Spain.
Our take: In Senate testimony on Tuesday, Fed Reserve Chair Powell continued to prepare the market for a “higher for longer” environment. Economic information will continue to direct the pace and ultimate endpoint of this rate hike cycle. The upcoming payroll numbers on Friday will be an important data point and market participants are beginning to think harder about what accelerated rate hikes might look like, whether they commence at this month’s meeting or not.
Municipal Market Commentary
- Last week high-grade tax-exempt bonds outperformed Treasuries by 1 bp in 2-years, but underperformed by 3, 2, and 9 bps in the 5-, 10- and 30-year maturities, respectively. AAA Muni/Treasury ratios ended the week at 62%, 63%, 66% and 93% and AA Muni/Corporate ratios finished at 60%, 61%, 60% and 84%.
- For the period ending March 1st, tax-exempt funds reported $199 million of outflows, consisting of $379 million of outflows from open-end funds and $180 million of inflows to ETFs.
- Municipal Bid Wanted volume reported by Bloomberg totaled $5.455 billion for the week.
- The new issue calendar this week totals $11.2 billion consisting of $5.8 billion of tax-exempt offerings and $5.5 billion of taxable issuance. The New York City Water Finance Authority is bringing $1.2 billion of tax-exempt bonds. Market participants will also be focused on two large taxable issues – $3.5 billion from the Texas Natural Gas Securitization Finance Corporation to provide rate relief to customers affected by Winter Storm Uri in February 2021, and a $1.9 billion issue of State of California General Obligation Bonds.
Our take: We anticipate a continued grind for the tax-exempt municipal market in the near-term as we work our way through Fed Chairman Powell’s Congressional testimony followed by non-farm payroll numbers on Friday. Municipals will continue to take direction from Treasuries and higher rates could lead to an increase in fund outflows. Municipal dealers saw an uptick in selling last week but advise that it is more driven by institutional investors making sector and duration adjustments rather than fund redemptions. At the same time Separately Managed Accounts and direct retail continue to demonstrate solid demand despite the rich relative value levels, and they seem to be reaching further out the curve in search of more yield and where ratios are a bit more attractive. This week’s calendar mix of tax-exempt and taxable new issue should aid price discovery. Deals will be priced to clear as the street has little appetite for inventory in advance of Friday’s employment numbers and the FOMC meeting later this month.
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