Weekly Fixed Income Commentary (April 6, 2023)
Corporate Bond Market Commentary
- U.S. High Yield tightened 64 bp last week to an OAS of 458 bp, and yields dropped to close at a more than three-week low of 8.52%.
- On a total return basis, US HY increased 1.8% on broad-based positive performance from BBs (+1.9%), Bs (+1.8%) and CCCs (+1.9%). On a YTD basis, US HY is +3.7% with CCCs (+4.9%) still leading Bs (+3.8%) and BBs (+3.4%).
- HY funds reported a net outflow of $2.1 billion last week but have resumed inflows in the current week.
- US HY primary markets reopened slightly after a three-week hiatus with a modest $600 million of supply. MTD issuance totals ~$4.7 billion, while YTD totals ~$39 billion.
- Option-adjusted spreads on US Investment-Grade bonds narrowed 10 basis points to 138 basis points over Treasuries in the past week, according to the Bloomberg US Corporate Investment Grade index.
Our take: A strong week of performance to end the quarter puts valuations at a more balanced level. There seems to be a huge disconnect between the risk rally and Fed pricing. Equities have fully recovered their SIVB selloff and HY credit spreads are tightening. The market is pricing in a goldilocks scenario where the banking crisis is over, growth is still strong, and the Fed’s hiking cycle is over. If the crisis is indeed over and growth is strong, then why are rates markets pricing only 48% chance of a 25bp point hike in May, and no more thereafter? On the flip side, the KBW bank index is still holding near the lows and is signaling continued worries. There’s no doubt we’re in a highly uncertain environment with a broad dispersion of views, but the disconnect between Fed pricing and risk assets doesn’t make a lot of sense and something needs to give – equities lower and credit spreads wider, OR interest rates have over-corrected and need to rise. We lean towards the former, which is why we have positioned the portfolio up in quality to be recession resilient AND take advantage of lower rates through duration as well.
Economic Commentary
- The ISM manufacturing index fell more than expected from 47.7 to 46.3 in March, with all five sub-indices under 50 for the first time since the financial crisis era 15 years ago.
- The March ISM Services fell from 55.1 to 51.2, more than three points below the 54.4 consensus estimate. Paired with Monday’s ISM Manufacturing, this survey suggests the economy rapidly cooled in March. New orders plummeted, supply chain components all improved, and the prices-paid component fell more than 6 points.
- The number of job openings in the U.S. dropped from 10.563 million to 9.931 million in February, under 10 million for the first time since May 2021. Openings peaked last March at 12 million. They have been dropping for some time, indicating the job market is not as tight as it was, even though readings above 7 million are consistent with an excessively restrictive labor market.
- Initial jobless claims of 228k were above consensus of 200k, and the previous reading was revised significantly higher, although a revision to seasonal adjustment factors clouds the picture somewhat.
Our take: The economy rapidly cooled in March according to the two ISM surveys released this week. Demand is slowing, supply chains are normalizing, and, most importantly for Fed policy, prices paid show much less significant price pressure. Labor markets are starting to show signs of weakness via declining job openings in the JOLTS survey and rising unemployment claims. Friday’s nonfarm payrolls and next week’s CPI and retail sales reports offer the first look at meaningful hard data for March, showing whether the ISMs accurately captured March economic momentum. This week’s data certainly reinforces the current market sentiment that expects less aggressive Fed policy this year than the Fed has projected.
Municipal Bond Market Commentary
- Last week high grade tax-exempt bonds outperformed Treasuries across the curve by 30, 22, 13 and 9 bps in the 2-, 5-, 10- and 30-year maturities. The continuing municipal outperformance generally drove ratios richer as AAA Muni/Treasury ratios ended the week at 59%, 62%, 65% and 90%, while AA Muni/AA Corporate ratios finished at 56%, 57%, 58% and 82%.
- For the period ending March 29th, tax-exempt funds reported outflows of $194 million, consisting of $104 million of outflows from open-end funds and $90 million of outflows from ETFs.
- The new issue calendar for the week totals $7.0 billion consisting of tax-exempt supply of $5.7 billion and taxable offerings of $1.3 billion. California paper dominates the calendar this week with $2.6 billion of State of California General Obligation bonds and $1.0 billion of San Francisco Wastewater bonds.
- Municipal Bid Wanted activity reported by Bloomberg declined 11% from the prior week. JPMorgan observed that bid wanted activity for longer duration bonds – 20+ years – declined 27% relative to historical averages.
Our take: Tax-exempts are continuing to outperform Treasuries as a limited new issue calendar and continued direct retail and SMA demand provides technical support. While aggregate flows were negative through the reporting week ending last Wednesday, combined inflows for Friday and Monday totaling $1.3 billion suggest a solid demand base for this week’s offerings. Institutions remain selective regarding structure and issuers will likely continue to include a variety of coupon structures in their offerings, particularly at the longer end. While the potential selling of municipal bonds by regional banks is still out there it has not upset the municipal market. Ongoing risks remain potential rate volatility in advance of the May FOMC meeting as well as the lack of any movement on debt ceiling negotiations. As the economy continues to slow, we anticipate that the drumbeat heralding the credit quality of municipal bonds will grow louder. Together with rates market stability following what may very well be the last Fed hike in May, this recognition of municipals as a “safe haven” should result in growing positive fund flows and solid tax-exempt bond performance in late Spring and Summer.
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