Weekly Fixed Income Commentary (May 4, 2023)
Corporate Bond Market Commentary
- US High Yield widened 7 bp last week to an OAS of 453 bp. The index now sits 28 bp tight to YE22. On a total return basis, US HY increased 0.5% on outperformance from CCCs (+0.9%) versus Bs (+0.4%) and BBs (+0.5%).
- On a YTD basis, US HY is +4.7% with CCCs (+7%) still leading Bs (+4.9%) and BBs (+4.1%).
- HY funds reported a net inflow of $594 million last week.
- US HY primary markets were relatively active last week with ~$3 billion of total volume.
Our take: While the HY market showed decent performance last week, much of that was on account of lower rates and risk-on in CCCs. Overall, the market has been relatively rangebound since the recovery from the depths of the March banking turmoil. Future performance will obviously be driven by rates and spreads. We believe the economy is slowing, and when this starts to become more apparent in official economic statistics and company results, rates will go lower, and spreads will widen. The current yield on BBBs and BBs is compelling, and when combined with a decline in rates, will cushion some or all of the impact of wider spreads, whereas lower credit quality bonds are less rate-sensitive and won’t see the same downside protection. We continue to advocate for an up-in-quality positioning overall, with certain idiosyncratic and special situations as well.
Economic Commentary
- Tax receipts came in stronger than expected last week, pushing a couple major institutions to revise their “x-date” estimates from early-summer to late July or early August. At the same time, Janet Yellen suggested that early June still remains a possibility for the X-date, which may or may not be a tactic meant to apply a sense of urgency to the discussions.
- The April Manufacturing ISM rose from 46.3 to 47.1, above the 46.8 consensus. The prices-paid component also rose more than expected, and the employment index climbed back above 50. Nonetheless, this shouldn’t change the overall economic narrative because the overheating worries in the economy are on the services side, and nothing in this report suggests manufacturing is in danger of overheating.
- The April Services ISM rose from 51.2 to 51.9, a tenth above the 51.8 consensus. The report’s sub-components suggest broad stability from March with strong demand, steadily rising input prices, and improving supply chain issues.
- The March JOLTS survey showed a significant decline in job openings and a notable fall in quits. Jobopenings fell to 9.74 million, quits fell from 3.98 million to 3.85 million, and layoffs in construction, accommodation and food service, and in healthcare jumped.
- Car sales, which popped in January, setting the tone for a surprisingly good showing by consumers in general in January that carried the quarter, just popped again in April to 15.91 million, the strongest since May 2021.
- The Federal Reserve raised interest rates 25 basis points, as expected. The statement deleted the language ‘some additional policy firming may be warranted’, while indicating that future actions will depend on various factors including monetary lag, the banking system, and other financial and economic developments.
Our take: More economic data suggesting weakness in manufacturing, some evidence of a plateau in the services sectors, and slow but steady progress in cooling the labor market. The banking system turmoil has not yet abated, with the failure of First Republic over the weekend and subsequent pivot to pressure on Western Alliance and PacWest. The Fed acted as the market expected and will now wait and see how the cumulative impact of all of the tightening from both rate increases, and financial conditions plays out. We believe the economy is slowing; if the Fed disagrees, they will over-tighten and ensure that it does. Prepare your portfolio accordingly.
Municipal Bond Market Commentary
- Last week high-grade tax-exempt bonds underperformed Treasuries by 26, 15, 11 and 9 bps in the 2-, 5-, 10- and 30-year maturities. Ratios cheapened with AAA Muni/Treasury ratios ending the week at 66%, 67%, 68% and 92% and AA Muni/AA Corporate ratios finishing at 64%, 62%, 60% and 82%.
- For the period ending 4/26/23 tax-exempt funds reported outflows of $92 million, consisting of $509 million of outflows from open-end funds and $417 million of inflows to ETFs.
- This week’s primary market calendar totals $6.3 billion, a manageable number, but larger than the calendars we have seen recently during the weeks of an FOMC meeting.
- Bloomberg reported total Municipal Bid Wanted activity of $5.6 billion for the week.
Our take: The continued cheapening of municipals relative to Treasuries is a result of several factors but especially ongoing volatility in the rates market and lack of new issue supply to support price discovery. Together with the noise around bank stress, reduction in municipal buyers (SIVB and Signature) and greater challenges for private funds in hedging tax-exempt positions given the Treasury market volatility, it makes sense that municipal yields should go up. The FDIC has begun the sale of municipal holdings acquired from the recent bank failures and it seems to be proceeding in an orderly manner. We do not expect JPMorgan to launch the $19 billion of municipal assets acquired in its purchase of First Republic anytime soon. Near-term headwinds for the municipal market continue to be this week’s FOMC meeting and subsequent policy activities — pause or additional hikes, and noise around a nearer-term Debt Ceiling “X-date.” Anticipated tailwinds continue to be robust reinvestment dollars over the next three months. As always stay tuned and buckle up.
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