Weekly Fixed Income Commentary (July 13, 2023)
Corporate Bond Market Commentary
- US High Yield bonds widened 3 bp last week to an OAS of 408 bp. The index now sits 73 bp tight to YE22. On a total return basis, US HY declined -0.6% on broad-based negative performance from CCCs (-0.5%), Bs (-0.5%) and BBs (-0.7%). On a YTD basis, US HY is up +4.8% with CCCs (+9.4%) leading Bs (+5.2%) and BBs (+3.5%).
- HY funds reported a net outflow of $283 million last week.
- US HY primary markets were quiet again last week, reflecting the July 4 holiday and renewed concerns over Fed policy and future rate increases. This followed ~$13 billion of total volume in June and ~$22 billion in May. YTD issuance in US HY now totals ~$93 billion.
- US Investment Grade spreads were 2 bp tighter last week to +128bp, while yields rose by 18 bp to 5.74%, resulting in total return losses of -1.28%.
Our take: Losses over the last several weeks were driven primarily by the rapid move higher in rates, somewhat offset by tighter spreads. This continues the trend of lower quality outperforming higher quality fixed income given it is less rate-sensitive and correlates more strongly with equities and other risk assets. The irony is not lost on us that high quality fixed income is on sale precisely at a time it is most attractive – when rates are close to peaking and the economy is poised to slow. We continue to believe that the up-in-quality, longer-in-duration trade is the right one. We also continue to trade around volatility and credit-pick attractive idiosyncratic situations.
Economic Commentary
- The June employment report was not as strong as expected, especially after the prior day’s blockbuster ADP, but it was not weak. Payrolls posted a solid gain, the unemployment rate dropped, and average hourly earnings growth exceeded expectations. Nevertheless, the headline job gain was short of expectations.
- Nonfarm payrolls rose 209k in June, with April revised down 77k to 217k and May down 33k to 306k, a net downward revision of 110k. With the revision, the net job gain was even weaker than the headline.
- The CPI rose 0.2% headline and core in June, resulting in an even bigger drop in year-on-year inflation than expected. The headline CPI fell year-over-year from 4.0% to 3.0% and the core CPI fell from 5.3% to 4.8%.
Our take: The recent move higher in intermediate and long-term rates was overdone. The CPI report likely doesn’t change a 25bp hike in July, but it could obviate the need for any further rate increases. There will be a lot of data before September, which should now be at least another skip, and even more by the November meeting. Those economic readings that are leading indicators are properly showing signs of rolling over and declining. The labor market is still tight but is known to lag. Those components of the job market which do tend to lead (large company employment, temporary jobs, job openings) are showing signs of weakness. Rates are in or around the peak, duration will be your friend…
Municipal Bond Market Commentary
- For the week ending July 7, 2023, high grade tax-exempt municipal bonds yields were 6, 6,7 and 6 bps higher across the curve at 2,5,10, and 30 years, outperforming US Treasuries in 2, 5, 10 and 30 years by 0, 14, 15 and 12 bps.
- Ratios were flat in the 2-year maturity and 1%, 2% and 3% lower in the 5-, 10-, and 30-year maturities, with AAA Muni/Treasury ratios ending the week at 59%, 62%, 64% and 90%. The AA Muni/AA Corporate ratio finished the week 1% higher in the 2-year, 1% lower in the 5 and 10-year, and 2% lower in the 30-year at 60%, 59%, 59%, and 78% respectively.
- For the period ending July 5, tax-exempt funds reported inflows of $184 million, with ETFs showing inflows of $312 million and open-end fund outflows of $128 million.
- The new issue municipal calendar is $7.9 billion for the week, $6.9 billion of which is tax-exempt and $956 million is taxable.
Our take: As in the prior week, the high-grade muni market outperformed US Treasuries amid a sell-off across the yield curve. Though we wouldn’t be surprised if the high grade muni market underperforms US Treasuries over the short term given the recent substantial outperformance, we make no changes to our near term outlook for continued richness in the muni market over the summer months, as new issuance is expected to be well short of reinvestment dollars from called and matured bonds, providing strong technical support for continued richness in municipal bonds. The current 30-day visible net supply is -$16.8 billion.
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