Weekly Fixed Income Commentary (September 28, 2023)
Economic Commentary
- Durable goods orders rose 0.2% in August, well above the consensus expectation for a 0.5% decline. Orders ex-transportation rose 0.4%, above the 0.2% consensus. Nondefense orders ex-aircraft (“core capital orders”) rose 0.9%, significantly higher than the 0.1% consensus. Core capital shipments rose 0.7%, above the consensus expectation for no change. Revisions to July data were down across the board, with the core capital orders change revised from a 0.1% increase to a 0.4% decline.
- Pending home sales declined 18.8% year-over-year as mortgage rates are pushing close to 8%. This should have a ripple effect on housing, building products, home furnishings and other related sectors.
- According to a recent report by Fitch, the percentage of credit card and auto loan balances transitioning to serious delinquency has surpassed pre-pandemic levels. This is even before the recent impacts of rising energy prices or the resumption of student loan payments are felt.
- 10yr TIPS real yields have reached 2.27%, the highest since before the Great Financial Crisis.
Our take: The sharp move higher in rates over the last several weeks is attributable to both fundamental and technical factors. The dramatic move higher in the long end of the curve has been a capitulation type move in prior rate cycles, when the market acknowledges a higher for longer posture and adjusts behavior accordingly. We won’t be surprised if these moves cause a shock and something ‘breaks’.
Corporate Bond Market Commentary
- US High Yield widened 14 bp last week to an OAS of 393 bp. On a total return basis, US HY declined -0.6% reflecting broad-based negative performance from CCCs (-0.7%), Bs (-0.6%) and BBs (-0.6%). Performance is currently tracking towards the worst monthly performance since September 2022.
- HY funds reported a net outflow of $416 million last week. Current week outflows are over $2 billion as the selloff intensifies, which would be the biggest weekly outflow since May.
- US HY primary markets were active again last week with ~$8 billion of total volume, one of the heaviest weeks of the year. We do expect activity to start to moderate from here as much of the identified pipeline has come to market. That should start to be more supportive from a technical perspective.
- US IG tightened 2bp and total returns were -0.32%. Inflows were $759 million.
- Only $16 billion of US IG issuance as the early month heavy cadence moderates.
Our take: We continue to believe that high quality bonds are on sale at exactly the time when they should be most attractive. As the economy slows and interest rates peak and eventually head lower, locking in over 6% on BBBs and almost 8% on BBs will be a winning move over the next 6-12 months, generating very attractive carry yields and gravy in the form of capital gains when rates eventually roll lower.
Municipal Bond Market Commentary
- For the week ending September 22, 2023, high grade tax-exempt municipal bonds yields were 17, 16, 21, and 19 bps higher at 2, 5, 10, and 30 years, underperforming US Treasuries by 9, 6, 11, and 8 bps at 2, 5, 10 and 30 years.
- AAA Muni/Treasury ratios rose 2% in the 2, 5, and 30 years and were up 3% at 10 years, ending the week at 66%, 68%, 71% and 92%. AA Muni/AA Corporate ratios were up 3% at 2, 5, and 10 years, and up 3% at 30 years to end the week at 67%, 66%, 66% and 83% respectively.
- For the period ending September 20, municipal bond funds reported outflows of $636 million, with ETFs seeing inflows of $525 million and open-end fund outflows of $1.2 billion.
- The new issue muni calendar is estimated to be $7.9 billion.
Our take: There is no change to our view that AAA Muni/Treasury ratios will likely trend higher over the coming months as Fall seasonal new issue supply is expected to exceed reinvestment of called and maturing securities. While we see headwinds to municipal relative value, the overall direction of the muni market will be largely dependent on changes in the US Treasury curve as the Fed tries to navigate the economy to the 2% target inflation rate without throwing the economy into recession.
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