Weekly Fixed Income Commentary (August 3, 2023)
Economic Commentary
- The Treasury Department announced it expects to borrow just over a trillion dollars this quarter, $274b billion higher than the May estimates and on track to be the highest quarterly borrowing on record.
- Fitch downgraded US Treasury debt one notch, from AAA to AA+. The decision came two months after a warning issued during the debt ceiling fight. The agency cited a lack of fiscal discipline evident in tax cuts, new spending initiatives, economic shocks and repeated political gridlock. We don’t expect the US credit downgrade from Fitch yesterday to have a significant bond market impact because: 1) Credit ratings are most helpful to markets when they provide information not widely available, usually when the subject is an emerging market country or small company; 2) the Treasury market is the most transparent and liquid market in the world, so credit rating agencies don’t add any new information about the fiscal trajectory markets don’t already know; 3) As such, changes in ratings from credit agencies tend to be lagging indicators rather than leading ones.
- The JOLTS report reinforced the idea that the labor market for manufacturing is not nearly as tight as a year ago, showing the fewest job openings in manufacturing since spring 2021 and the lowest quits rate since late-2020.
- The Senior Loan Officers’ Outlook Survey on bank lending practices (SLOOS) showed an increasing number of banks tightening standards for commercial and industrial loans. They are also increasing spreads over their cost of funds on these loans. Nevertheless, there was a modest downtick in the number of banks reporting weaker C&I loan demand.
- PCE core deflator declined from 0.3% to 0.2% (4.6% to 4.1% yoy).
- GDP came in at a strong 2.4%, while the GDP price index moderated from 4.1% to 2.2%, below expectations of 3.0%.
- The employment cost index declined from 1.2% to 1.0%, below estimates of 1.1%.the smallest increase since it rose 0.7% in the second quarter of 2021. The Fed pays close attention to the ECI because it is a broader measure of employment costs than average hourly earnings. It includes wages, salaries and benefits, it covers a broader swath of the economy, and it is weighted. The index dropped from 1.2% in Q1 and reflects 1.0% growth in wages and salaries and 0.9% growth in benefits. On a year-on-year basis, compensation growth slowed from 4.8% to 4.5%. The peak was last year in the second and fourth quarter, when compensation growth was 5.1%.
Our take: The last several trading days have marked a battle between the fundamentals of a slowing US economy versus un-tethering of JGB yields by the Bank of Japan and the increasing future supply of US Treasuries. At the moment, the improvement in the inflation picture is being overwhelmed by rising yields in Japan and fear of elevated UST supply, all of this happening in August, when market liquidity is notoriously poor. We believe that fundamentals will punch back and eventually win the battle, and yields are close to their peak.
Corporate Bond Market Commentary
- U.S. High Yield tightened 7 bp last week to an OAS of 382 bp. The index now sits 99 bp tight to YE22.
- On a total return basis, US HY was up +0.1% reflecting outperformance for CCCs (+0.4%) versus Bs (+0.1%) and BBs (flat). On a YTD basis, US HY is up 6.7% with CCCs (+12.3%) leading Bs (+7.1%) and BBs (+5.2%).
- HY funds reported a net outflow of $376 million last week. US HY primary markets remained relatively active last week with ~$2.5 billion of total volume. YTD issuance now totals ~$99 billion.
- U.S. IG spreads tightened 7bp to +119bp, while yields rose 3bp to 5.54%, resulting in total return losses of -0.20%. Issuance was $14.7 billion for the week, below expectations of $20-$25 billion. Fund inflows were $1.15 billion, running the streak to 8 weeks of positive flows.
Our take: Markets were strong last week as consensus began to build around a soft landing and a delayed onset of recession. However, risk has reversed over the last several trading days as earnings have been mixed and the spike in interest rates has roiled markets and started to trigger outflows. We believe a pullback is warranted, if not overdue, and August doldrums tend to be a lightning rod for such volatility. We are prepared accordingly, with up-in-quality positioning and an above-average cash position we are anxious to deploy into any dislocation.
Municipal Bond Market Commentary
- For the week ending July 28, 2023, high grade tax-exempt municipal bonds yields were 8, 6, 5, and 6 bps higher across the curve at 2,5,10, and 30 years, underperforming US Treasuries by 4 bp in the 2 year and outperforming US Treasuries by 3, 7, and 6 bps in the 5, 10, and 30 year, respectively.
- Ratios were 1% higher at 2 years, unchanged at 5 and 10 years, and 1% lower at 30 years, with AAA Muni/Treasury ratios ending the week at 60%, 62%, 64% and 89%. AA Muni/AA Corporate ratios finished slightly higher at the short end and unchanged at the long end, finishing the week at 61%, 60%, 59%, and 79% in 2, 5, 10 and 30 years.
- For the period ending July 26, tax-exempt funds reported inflows of $552 million, with $250 million inflows into ETFs and $302 million into open-end funds.
- The new issue muni calendar is heavier than usual, with $10.7 billion in tax-exempt and $237 million in taxable issuance expected.
Our take: As we would have expected given the technical support, the muni market outperformed US Treasuries along most of the curve. We would expect this trend to continue if the US Treasury yields move higher but would expect slight underperformance if both US Treasury and muni markets were to rally. The technical supply imbalance remains in place as does 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. Current visible net supply is -$16.4 billion.
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