Weekly Fixed Income Commentary (June 8, 2023)
Corporate Bond Market Commentary
- S. High Yield tightened 16 bp last week to an OAS of 437 bp. On a total return basis, HY rose 1.2% on broad-based positive performance for BBs (+1.3%), Bs (+1.1%) and CCCs (+1.1%).
- On a YTD basis, US HY is now +4.6% with CCCs (+7.2%) still leading Bs (+4.9%) and BBs (+3.9%).
- HY funds reported a net outflow of $2.2 billion last week but returned to strong inflows towards the latter part of the week.
- HY primary markets were quiet for much of last week after ~$23 billion of issuance in May. The largest share of issuance came from BB-rated companies, which priced $9 billion; B-rated companies issued $5 billion and CCC-rated companies issued just $400 million.
- The US IG index tightened -2 bp on the week to 139 bp, closing in on the mid-April tight of 139 bp, while yields fell -13 bp to 5.48%, driving weekly total return gains of 1.0%.
Our take: We have survived the banking system instability, the debt ceiling cliffhanger, and Q1 earnings season. There should be some calm water until Q2 earnings begin in mid-July, barring preannouncement tape bombs. We expect to see continued dispersion, where higher quality credits are resilient through a slowing economy, while lower quality credits struggle to drive revenue, maintain margins, service higher-cost debt and refinance debt maturities. With all-in yields on BBBs and BBs at attractive levels, generally there is no need to reach down too far in credit quality at this point in the cycle except for certain idiosyncratic or catalyst-driven situations.
Economic Commentary
- Last week’s labor market data offered mixed news – strong gains in employment on one hand, versus a higher unemployment rate, lower average hourly earnings, and fewer aggregate hours worked. This is logical because many of the jobs being added are in lower-wage sectors.
- The May ISM Services fell from 51.9 to 50.3, a couple points below the 52.4 consensus. Demand slowed, supply chains improved, and price pressures cooled slightly. The broad signs of cooling will firm market expectations for a rate pause at next week’s FOMC meeting.
- With the data calendar pretty light this week and Fed officials in the pre-meeting blackout period, markets should be in a bit of a holding pattern until next Tuesday’s CPI.
Our take: It is very common at inflection points in the economic cycle for labor market data to be volatile and inconsistent. Overall, we believe the labor market is cooling, but it may take more time for companies to actually part with workers after struggling to hire and retain them for so long. The market is expecting the Fed to skip a hike at the June meeting, and most likely hike 25 basis points in July. September is too far away at this point to make a call, but our inclination is that by then, there will be more clear evidence the economy is slowing, and the job market is cooling sufficiently to hold rates steady for a while. Duration is your friend.
Municipal Market Commentary
- For the week ending June 2, 2023, looking at the data in the 2-, 5-, 10- and 30-year maturities, high grade tax-exempt bond yields fell 16, 17, 13 and 12 bps, which outperformed US Treasuries by 8, 6, 0 and 2 bps. AAA Muni/Treasury ratios ended the week at 66%, 69%, 70% and 93% for the 2-, 5-, 10-, and 30-year tenors. AA Muni/AA Corporate ratio finished the week at 67%, 65%, 63%, and 79% respectively, similarly just slightly richer across the curve.
- For the period ending May 31, open-end municipal bond funds reported outflows of $1.4 billion and while ETFs had $358 million in inflows.
- The municipal new issue calendar is $9.0 billion this week, comprised of $8.4 billion in tax-exempts and $611 million of taxable munis.
Our take: Muni market yields fell with the rally in the US Treasury market on Monday through Thursday and even rallied slightly as US Treasury yields rose on Friday after the monthly employment numbers were released. With the debt ceiling bill passing both the House and Senate and signed by President Biden, the focus for the muni market has shifted back to the Federal Reserve and how they will respond to current economic data. The FDIC sale of the municipal portfolios continues with little market disruption, with an estimated 25% of the $6.9 billion in tax-exempt bonds being sold to date. We continue to believe the tax-exempt muni markets will remain rich through the summer months due to strong market technicals with re-investment dollars exceeding new issuance. Bloomberg currently shows visible net supply at -$26.95 billion. We’ll continue to search for idiosyncratic opportunities, but the primary focus of new investments continues to be in taxable fixed income securities until tax-exempt municipals cheapen on a relative basis.
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