Weekly Fixed Income Commentary (December 21, 2023)
Economic Commentary
- Several Fed officials spoke over recent days, pushing back on the market reaction over the last week and adding nuance to their own individual outlooks. We expect that it will take a Powell appearance and/or the combination of Fed speak and a big data release for markets to be convinced enough to shift their expectations. Otherwise, there’s little evidence so far the market is buying what the Fed is selling.
- In labor markets, a rebound in immigration is fueling an increase in labor supply that is exceeding job growth; this will push the unemployment rate higher and slow wage growth even without large scale job losses.
- Retail spending surprised to the upside in November, suggesting consumption did not collapse after its strong third quarter showing, despite a pause in October. Retail sales rose 0.3% in November, beating a consensus forecast of a 0.1% decline. Retail sales excluding autos rose 0.2%, also beating expectations of a 0.1% decline. Sales excluding autos and gas rose 0.6%, handily trouncing the 0.2% consensus. Control group sales rose 0.2%, also beating the consensus for no change.
- The Conference Board’s consumer confidence index jumped to 110.7 from 101.0, a five-month high and well above the consensus, 104.5.
Our take: Goods inflation is already close to zero. Housing-related inflation will moderate over the coming months. Labor market softening will feed through to services disinflation. All put together, overall inflation will decline, and the Fed will need to cut rates simply to avoid policy remaining too restrictive. There is a misconception by many that the Fed needs to see a recession in order to start to cut rates; simply a sustained move lower in inflation data will push the Fed to cut so that real rates aren’t too high. Rates will continue to move lower in 2024, albeit not in a straight line, more cash will be re-allocated from cash/money markets/equities into bonds, and these fund flows will provide further support for bond price performance.
Corporate Bond Market Commentary
- US High Yield tightened 24 bp last week to an OAS of 351 bp. The index now sits 130 bp tight to YE22. On a total return basis, US HY climbed +1.9% on continued outperformance from CCCs (+2.6%) versus Bs (+1.9%) and BBs (+1.8%).
- US HY primary market activity cooled somewhat last week, bringing the YTD volume total to ~$175 billion.
- HY fund inflows were +$1.8 billion.
- US IG spreads tightened 6bp to +104bp and total returns were +2.6%.
- Four issuers tapped the market pricing $2.5 billion of new issue supply. Fund flows were +$3.5 billion.
Our take: The massive rally in bonds continued last week on strong fund inflows and negligible new issue supply. We expect the positive performance -> fund inflows feedback loop to continue generally, albeit with some hiccups along the way. New issue supply should explode in January, as issuers take advantage of the significant move lower in rates and spreads to start to tackle their 2024 and 2025 funding needs. This wave of supply could weigh on spreads, and we have trimmed some positions into this huge rally, with the intention of taking advantage of attractive new-issue concessions right out of the chute in early January.
Municipal Bond Market Commentary
- For the week ending December 15, high grade tax-exempt municipal bonds yields continued to rally, falling 19, 20, 21 and 20 bps at 2, 5, 10 and 30 years, underperforming US Treasuries with US Treasury yields falling by 28, 33, 31 and 30 bp at 2, 5, 10 and 30 years.
- AAA Muni/Treasury ratios richened by 1% at 2 years and 1% cheaper at 30 years with the 5- and 10-year ratios holding steady, ending the week at 57%, 58%, 60% and 86%. AA Muni/AA Corporate ratios also richened, falling 1-3 percent from 2-10 years and 1% cheaper at 30 years to end the week at 57%, 56%, 55% and 80% respectively.
- For the period ending December 13, municipal bond funds reported outflows of $524 million.
- The new issue muni calendar is expected to be $1.54 billion, with a lighter than normal schedule anticipated through year end due to holidays.
Our take: Muni ratios have continued to richen across much of the curve and continue to be supported by negative net visible supply. The primary direction of the muni market will continue to be dictated by changes to the US Treasury curve, especially as inflation and related data feed into the market’s expectations of future Fed actions. In spite of the large recent rally, municipal bond yields are still at levels not seen for a decade until recently.
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