Weekly Fixed Income Commentary (April 20, 2023)
Corporate Bond Market Commentary
- U.S. High Yield tightened 41 bp last week to an OAS of 443 bp. The index now sits 38 bp tight to YE22.
- On a total return basis, U.S. HY rose 0.8% on outperformance from CCCs (+1.1%) versus Bs (+1%) and BBs (+0.6%). On a YTD basis, US HY is +4.5% with CCCs (+5.9%) still leading Bs (+4.7%) and BBs (+4.1%).
- HY funds reported a net inflow of $235 million last week.
- S. HY primary markets were active again last week bringing the monthly total to ~$12 billion. Notable issuers included Cleveland Cliffs (Ba3/BB-), Baytex Energy (B1/BB-) and Conuma Resources (Caa1/CCC+). YTD issuance now totals ~$51 billion.
- IG spreads tightened 6bp last week from +140 to +134, but total returns were -0.95% as treasury yields rose ~12 bp.
Our take: Corporate bonds have rallied as sentiment continues to improve from the depths of the March banking crisis. Whether this streak can continue will largely depend on corporate earnings and forward guidance over the coming weeks. Early reads from banks that have reported so far indicate some stability, albeit with lower profitability due to rising deposit costs. Much of the easy recovery gains are behind us, and performance going forward should be more idiosyncratic and lend itself to credit picking by active managers.
Economic Commentary
- The latest Fed Beige Book showed early warning signs of tightening credit. Some Districts reported “banks tightened lending standards amid increased uncertainty and concerns about liquidity.” The San Francisco Fed reported that “lending activity decreased substantially”, although not a surprise given the localized impact of Silicon Valley Bank.
- House Republicans started positioning their debt ceiling “wish list” this week. The related headlines stir renewed interest in when the limit will actually freeze government payments. What matters is we should soon have a timeline and therefore a better sense of when we should start to care about the back and forth.
- The University of Michigan sentiment survey saw 1yr ahead inflation expectations spike back up to 4.6%, a reversal vs the prior month’s 3.6%, but possibly explained by the recent uptick in gasoline prices. Longer-term inflation expectations in the survey were anchored at an unchanged 2.9%, which is more relevant to us.
- Retail sales were disappointingly weak in March, but the weakness was mostly explained by a bigger-than-expected 5.5% drop in gasoline sales, as control group sales only fell -0.3%.
- The PPI fell 0.5% in March, but the core rose just 0.1%. Both were considerably lower than expected. On a year-on-year basis, producer price inflation slowed from 4.9% to 2.7% headline and from 4.5% to 3.6% core.
Our take: Producer inflation appears to be steadily declining, whether judged on a year-on-year basis or on a monthly basis. Inflation was persistently bad through most of 2021 but has been restrained at the wholesale level most of this year and dropped the most in March since April 2020. The link between the PPI and CPI is not as clear as it once was, but persistently small increases — or, as in March, an outright decline — should eventually come through to consumers and therefore it makes sense to be optimistic on the future path of inflation. At the same time, tightening bank lending coupled with an expectation of rising rhetoric over the debt ceiling warrants a bit of caution over the coming weeks. We are raising additional cash to take advantage of this expected volatility.
Municipal Bond Market Commentary
- Last week high grade tax-exempt bonds outperformed Treasuries by 13 bps in the 2-year maturity, 12 bps in the 5-year maturity and by 14 bps in the 10- and 30-year maturities. Ratios continued to richen with AAA Muni/Treasury ratios ending the week at 54%, 58%, 60% and 83% and AA Muni/AA Corporate ratios finishing at 54%, 53%, 53% and 76%.
- For the period ending 4/12/23 weekly and monthly reporters indicated combined outflows of $1.3 billion, consisting of $1.2 billion of outflows from open-end funds and $136 million of outflows from ETFs. Through this reporting date aggregate outflows total $3 billion.
- Primary market offerings this week total $12.5 billion and this is the largest new issue calendar of the year so far, more than double the weekly average of $6 billion to this point. Larger issues on the calendar include $2.3 billion of State of Illinois General Obligation Bonds and $1.1 billion of New Jersey Economic Development Authority bonds.
- Bloomberg reported total Municipal Bid Wanted activity of $6.25 billion for the week.
Our take: As this week begins, we are seeing weaker municipal market performance. Fund outflows have continued over the past several days since the last full weekly report. In addition, the combination of rich relative values and the larger primary market calendar is leading to increased selling as we start the week. JPMorgan reported that Monday’s bid wanted volume was 37% higher than the same day’s 5-week average. We believe selling is not solely driven by fund redemption requirements but rather also by a desire to raise cash in anticipation of an opportunity to buy new issues priced with a concession during a heavier supply week. This near-term pain in performance will be unpleasant but can bring about a healthy adjustment to ratios that will be supportive of longer-term positive performance as we enter a favorable technical environment a bit further down the road.
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