Weekly Fixed Income Commentary (March 16, 2023)
Corporate Bond Market Commentary
- IG credit spreads widened 16 bps WoW to 136 bps, while yields decreased 10 bps to 5.4%, for a total return gain of 0.8% and leaving year-to-date performance at +1.69%.
- IG fund flows decelerated to $1.7 billion in inflows, the smallest weekly inflow YTD, while supply decelerated WoW to $44.7 billion.
- HY credit spreads widened 53 bps this past week to 450 bps and yields rose 27 bps to 8.8%. Total return was down -0.9% WoW, extending recent losses to -3.4% and leaving YTD total return at +1.87%.
- Across ratings, CCCs(-1.1%) and single-B’s(-1.0%) underperformed while BBs (-0.8%) fared slightly better.
- HY fund flows flipped to $0.4 billion in inflows, its first inflow in four weeks, while supply decelerated WoW to merely $0.5 billion.
- HY dealer inventory was flat WoW at $3.0 billion, as dealers trimmed positions in 1-10 year while added roughly the same amount in very front and long-end of the curve. In more recent days, HY dealer inventories have declined substantially.
Our take: Spreads have widened substantially in reaction to the stress in the financial system and the failures of Silicon Valley Bank and Signature Bank. The regional banking system is under pressure, as the market hunts-down financial institutions with large uninsured deposit bases, asset/liability mismatch issues or other characteristics that are signs of instability and susceptibility to a run on deposits. At the same time, interest rates have plunged as the market reassessed the likely path of interest rates and the economic cycle. This stress on the financial system is akin to several rate increases, as it further tightens financial conditions. This likely pulls forward the timetable on a recession and obviates the need for as many FOMC rate hikes. We continue to favor higher quality fixed income given their greater resiliency in a downturn. Overall interest rates should be heading lower and would offset additional spread widening, unlike lower quality bonds where spread widening would more likely overwhelm the decrease in the risk-free rate. We have raised a little cash anticipating more bargains amidst the volatility and look forward to deploying it tactically.
Economic Commentary
- February payrolls came in +311k, above the +225k expectation; however, the decline in average hourly earnings and the tick up in the participation rate somewhat cushioned the blow.
- CPI came in largely consistent with expectations at +0.4% overall and +0.5% ex-food and energy, while PPI softened meaningfully and offered optimism that wholesale prices are moderating, which would eventually flow through to final prices.
- Empire manufacturing came in at -24.6, way below both prior month -5.8 and expectations of -7.9.
Our take: When central banks raise interest rates and financial conditions tighten, these stresses will eventually expose cracks and weaknesses in the system, which is exactly what has happened over the last week. Extraordinary measures are being put in place to prevent contagion, and we would expect that these will generally prove successful but there will be additional casualties and failures. We still expect the FOMC to raise rates 25 bps next week, but then watch both economic data and the ripple effects in the financial system before determining whether they are done with the hiking cycle or not.
Municipal Market Commentary
- High-grade tax-exempt bonds declined last week by 16, 9, 12 and 12 bps in the 2-, 5-, 10- and 30-year maturities last week, but underperformed the rallying Treasury market by 11, 20, 15 and 7 bps across the curve. AAA Muni/Treasury ratios ended the week at 62%, 65%, 68% and 94% and AA Muni/Corporate ratios finished at 57%, 59%, 59% and 84%.
- For the period ending March 8th, tax-exempt funds reported $650 million of outflows, consisting of $444 million of outflows from open-end funds and $206 million of outflows from ETFs.
- Municipal Bid Wanted volume totaled approximately $4.9 billion for the week.
- Last week’s mix of tax-exempt and taxable new issues was well received. The $3.5 billion taxable Texas Natural Gas securitization transaction saw over $16 billion in orders, and the tax-exempt Triborough Bridge and Tunnel deals also saw strong interest and was upsized from $800 million to $1.25 billion. This transportation credit is backed by sales taxes rather than user fees. It is noteworthy that over $800 million of the issue was structured in maturities 2053 and longer, employing a variety of coupons — 4.125%, 5.25%, 4.25%, 5.5% and 4.5%.
- This week’s primary market calendar totals $7 billion including $950 million New York City Transitional Finance Authority revenue bonds and $660 million Oregon general obligation bonds.
Our take: We currently believe that municipal market participants will continue to take direction from the Treasury market but perhaps with a bit less speed and conviction. Fund flows over the last several days are not indicating a run to the exits. While bid/offer spreads have widened a bit indicating some dealer risk aversion, institutional selling reflects repositioning more than any need to meet investor redemptions. The rapid fall of a large financial institution certainly gives investors pause and increases the focus on safety and security. With this in mind investors should remember the high credit quality and low default characteristics inherent in the municipal bond market as a whole. Another reasonable question on tax-exempt investor minds in the aftermath of the SIVB failure is whether bank selling of municipal bonds will put untenable pressure on the market that will cause significant price declines. Our view is that while there may be some municipal position selling from SIVB and other regional banks we expect that the market will be able to readily absorb this, especially if the current lack of primary market new issues continues. We also note that this event can present a buying opportunity as some sectors more closely linked to financial institution credit – for example, the “Pre-Pay Gas” sector, may cheapen as bank credit overall is beaten up in the aftermath of the recent SIVB failure.
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