Weekly Fixed Income Commentary (November 9, 2023)
Economic Commentary
- October payrolls rose 150K, below the consensus, 180K. The net revision was a sizeable -101K. The unemployment rate rose a tenth to 3.9%, above the consensus, 3.8%.
- The unemployment rate rose because reported employment fell faster (-348K) than the labor force (-201K). The trends show that the labor force is expanding rapidly – the 12-month average is 257K, thanks in part to rebounding immigration – while household employment has averaged 219K. As a result, the unemployment rate is creeping higher, and is on course to breach the 4.0% mark soon. That would represent a half-point increase from the cycle low; if sustained for three months, this will trigger the Sam Rule, which notes that every time unemployment rises by a half-point, the NBER subsequently declares that the economy was in recession at that time.
- Average hourly earnings rose 0.2%, a tenth below the consensus, 0.3%. Unit labor costs declined -0.8%.
- 7% productivity growth on the heels of a 3.6% rise in Q2 marks the first back-to-back solid rise since before the Pandemic Recession. This should help bring down cost pressures in the labor market.
- According to one sell-side strategist, “the ‘recession question’ has continued to dominate many a client conversation. We would highlight once again that we think that question is a ‘red herring’. When we look at history, below trend growth and restrictive policy have been a challenging mix. This is particularly for leveraged capital structures, as subpar growth hits operating fundamentals at the same time that high policy rates put upward pressure on the cost of capital, Indeed, when we look at excess return performance during periods of sub 2% real GDP growth and > 4% Fed Funds we have only seen one quarter of strong performance over the past 30 years, and that quarter was a bear market rally sandwiched between two large selloffs.”
Our take: The combination of a dovish Fed, softer economic data, better inflation indicators and a tweak to expected future UST issuance sizes – combined with big rate shorts and not heavy risk positioning has all driven a pretty substantial squeeze across markets. Oil prices have declined substantially, the labor market is finding better balance (especially if productivity is increasing and immigration is rebounding), and we still haven’t come close to consumers feeling the sting of higher rates. Minneapolis Fed President Neel Kashkari said the other night that he’d prefer overtightening to doing too little – we think he is likely to get his wish. While rates will remain volatile, within a range, the peak is behind us and the trading range will continue to grind lower.
Corporate Bond Market Commentary
- US High Yield tightened 49 bp last week to an OAS of 404 bp. The index now sits 77 bp tight to YE22. On a total return basis, US HY rose 2.7% on outperformance for BBs (+3.1%) versus Bs (+2.6%) and CCCs (+1.5%). On a YTD basis, US HY is now +7.2% with CCCs (+11.5%) still leading Bs (+7.9%) and BBs (+5.8%).
- US HY primary market activity was modest again last week, with three issuers pricing less than $2 billion. YTD volume in US HY now totals only ~$145 billion.
- HY fund flows were a $587 million inflow.
- US IG spreads tightened 2bp to +129bp. Total returns were +1.94%. Companies took advantage of the rally in bonds and issued $30.5 billion, well ahead of initial expectations of $15-$20 billion. Fund flows were +$923 million.
Our take: The rally in rates combined with modest inflows (to start) and light new issue supply sparked a rally in corporate bonds. The inflows picked up steam as investors rushed into bonds believing rates may have peaked, as over $5 billion has come into HY ETFs this week, the most since weekly data began in 2018. Mutual funds also pulled in significant flows as well. Don’t say we didn’t tell you… While this major move lower in rates will likely see a pullback and continued volatility alongside economic data and seasonal factors, we still strongly advocate for investors to start to move out into duration on high quality corporate bonds – IG, BBs and select Bs, to start to lock in these once-in-a-cycle type yields. Six to twelve months from now people will rue the decision not to.
Municipal Bond Market Commentary
- For the week ending November 3, high grade tax-exempt municipal bonds yields fell 25, 26, 27 and 27 bps at 2, 5, 10 and 30 years, outperforming US Treasuries by 9, 1 and 2 bps at 2, 10 and 30 years, and moving with Treasuries at 5 years.
- AAA Muni/Treasury ratios fell 2, 2, 1, and 1 percent at 2, 5, 10, and 30 years, ending the week at 73%, 73%, 74% and 92%. AA Muni/AA Corporate ratios fell 1, 1, 1, and 3 percent at 2, 5, 10 and 30 years, to end the week at 70%, 69%, 67% and 81% respectively.
- For the period ending November 1, municipal bond funds reported outflows of $1.5 billion, with muni ETF outflows of $60 million and open-end mutual fund outflows of $1.4 billion.
- The new issue muni calendar is estimated to be $9.8 billion.
Our take: The muni market continues to be pulled around by the volatility in the US Treasury market, and both rallied substantially in the wake of a lighter Treasury auction calendar, signs of a loosening job market in the monthly nonfarm payrolls report, and dovish post-FOMC language from the Fed. In spite of the volatility, we believe this is an opportune time to invest in high grade municipals as after-tax yields remain at the highest levels in over a decade.
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