Weekly Fixed Income Commentary (August 17, 2023)
Economic Commentary
- Real yields back near 1.7% are at the highest levels since before the 2008 financial crisis.
- FOMC minutes reveal that participants now view risks as more balanced; consensus will be more difficult to achieve at future meetings, which isn’t unexpected at this point late in the rate hike cycle.
- Next week’s Jackson Hole Economic Policy Symposium is an opportunity for Powell to shed some light on recent events and data.
- The Atlanta Fed Nowcast for Q3 GDP is up to 5.8%, while the St. Louis Fed’s model is at 0.59%.
Our take: 10yr and 30yr UST rates are at cycle highs not seen since 2008 and 2011 respectively. Concerns that the economy is proving resilient are valid, but the assumption is that the Fed will be ok with unabated growth and a higher inflation rate; we believe they won’t and thus will continue to tighten and remain restrictive until the job conquering inflation is clearly done, not ‘maybe done’. Short term rates will remain high, but the eventual effect will be a slowing of the economy and deflation, pushing the longer end of the curve lower. Essentially, these higher long-term rates are doubting the resolve of the FOMC to maintain a 2% inflation target and get the job done. August thin trading volumes are exacerbating the move. Longer-term rates seem ripe for a snap-back, possibly as soon as Jackson Hole next week or when traders return from August vacations after Labor Day.
Corporate Bond Market Commentary
- U.S. High Yield tightened 18 bp last week to an OAS of 383 bp. The index now sits 98 bp tight to YE22. On a total return basis, US HY was up +0.3% reflecting significant outperformance for CCCs (+1%) versus Bs (+0.4%) and BBs (+0.1%). On a YTD basis, US HY is now +6.6% with CCCs (+12.8%) leading Bs (+7.2%) and BBs (+4.9%).
- HY funds reported a net outflow of $559 million last week.
- US HY primary market activity accelerated last week with almost $5 billion of total volume. Capitalizing on still-tight spreads and a light calendar for new bond sales, banks sold the hung debt tied to Apollo’s takeover of Tenneco. The offering included $1.9 billion 5.3-year notes, sold at a discount to yield 11.933%. Orders for the notes were about $2.5 billion and the size was boosted from $1.75 billion. In a telling sign, the notes traded down 2 points immediately.
- HY dealer inventory reached $4.6 billion, the highest net long position since July 2021.
Our take: Technicals in the HY market are worsening – increasing new issue supply, very heavy dealer inventories, and volatile to negative fund flows. Although the market is weathering the August doldrums and rate volatility so far, September often brings nasty surprises and ugly performance. We wouldn’t be surprised to see post-Labor Day bring another September to remember.
Municipal Bond Market Commentary
- For the week ending August 11, 2023, high grade tax-exempt municipal bonds yields were 4 bps lower across the curve at 2,5,10, and 30 years, outperforming US Treasuries by 17, 21, 16, and 10 bps in 2, 5, 10, and 30 years respectively.
- As might be expected with the relative outperformance, AAA Muni/Treasury ratios were lower ending the week at 63%, 64%, 65% and 88% at 2,5, 10, and 30 years. AA Muni/AA Corporate ratios also moved lower, finishing the week at 63%, 62%, 62%, and 78% in the 2, 5, 10 and 30 years.
- For the period ending August 9, municipal bond funds reported inflows of $278 million.
- The new issue muni calendar is estimated to be $7.49 billion.
Our take: The muni market was firm with slightly lower yields, in contrast to the US Treasury market that experienced a significant selloff and higher yields. The summer seasonal technical supply imbalance is disappearing, with the current visible net supply at only -$3.5 billion. Without the substantial negative net supply there is a strong likelihood that AAA Muni/Treasury ratios will move higher over the next several months, but the overall direction of the market will still be dictated primarily by changes in the US Treasury curve.
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