Weekly Fixed Income Commentary (October 5, 2023)
Economic Commentary
- The September ISM Manufacturing index rose from 47.6 to 49.0, above the 47.9 consensus. This still suggests slight contraction in the goods side of the economy, but it’s a healthy recovery from a three-year low of 46.0 in June.
- We dodged a potential near-term issue as Congress passed a short-term funding bill that will keep the government funded until November 17th. However, the ouster of Speaker McCarthy may complicate things going forward, at least in the near-term.
- The September ISM Services index fell from 54.5 to 53.6, a tenth above the 53.5 consensus.
- Oil prices have started to roll over, after reaching highs of $94, they are down below $84 on concerns around the economy. Other commodities such as copper began discounting an economic slowdown a while ago, while oil was the holdout due to supply side constraints orchestrated by Saudi Arabia and Russia.
- All eyes are on Friday’s payroll report for direction on the labor market and implications for rates and Fed policy.
Our take: The sharp move higher in rates has reached levels where it feels like something might break – a bank, a levered hedge fund, muni TOB programs, CDOs, or other levered structures. With oil prices starting to discount a slowdown, the implications for inflation, the dollar and rates could be the trigger for a stabilization if not a snap-back in rates.
Corporate Bond Market Commentary
- US High Yield widened 10 bp last week to an OAS of 403 bp. On a total return basis, US HY declined -0.4% reflecting broad-based negative performance from CCCs (-0.7%), Bs (-0.4%) and BBs (-0.4%).
- HY funds reported a sizeable net outflow of $2.4 billion last week.
- US HY primary markets were active again last week with $5 billion across seven issuers, bringing the September total to ~$24 billion, the most active month this year.
- US IG was 4bp wider to +124. Total returns were -1.02%. Outflows were -$1.7 billion. New issuance was $18 billion, pushing September to $124 billion.
Our take: The poor returns / fund outflows negative feedback loop has begun and started to accelerate in the current week. New issuance should be more subdued as most of the visible pipeline has been cleared, earnings blackouts are getting underway, and all-in yields are painfully high for anyone other than those issuers to really need to come to market. The alleviation of supply will help markets stabilize, starting from higher quality first, once rates begin to stabilize. The recent period has been painful, but all-in yields on higher quality bonds have reached levels where forward returns are very compelling.
Municipal Bond Market Commentary
- For the week ending September 29, 2023, high grade tax-exempt municipal bond yields rose 29, 29, 28, and 25 bps at 2, 5, 10, and 30 years, underperforming US Treasuries by 36, 24, 15, and 8 bps respectively.
- AAA Muni/Treasury ratios rose 6%, 5%, 4% and 2% in 2, 5, 10 and 30 years, ending the week at 72%, 73%, 75% and 94%. AA Muni/AA Corporate ratios were also higher, up 4% at 2, 5, and 10 years, and up 1% at 30 years to end the week at 71%, 70%, 70% and 84% respectively.
- For the period ending September 27, municipal bond funds reported outflows of $1.2 billion, with ETFs seeing inflows of $26 million and open-end fund outflows of $1.2 billion.
- The new issue muni calendar is estimated to be $8.5 billion.
Our take: There is no change to our view that AAA Muni/Treasury ratios will continue to 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. The rising US Treasury curve has pushed long dated high grade muni yields to levels not seen since 2013 while the short-end of the curve is at yield levels last seen during the Great Financial Crisis 15 years ago.
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