Weekly Fixed Income Commentary (January 25, 2024)
Economic Commentary
- The January Michigan consumer sentiment index surged to 78.8 from 69.7, significantly above the consensus of 70.0. The surge in the Michigan index to its highest level since July 2021 largely reflects the fall in gas prices and rise in stock prices towards the end of last year.
- The core PCE deflator, which Fed officials view as the best measure of the underlying pace of consumer price inflation, rose at an annualized rate of only 2.0% on a sequential basis in Q4, the second consecutive quarter in which prices have risen at the FOMC’s target of 2%.
- Fourth quarter GDP rose 3.3%, above expectations of 2.0% and above the latest Atlanta Fed GDP now forecast of 2.38%.
Our take: The economy has remained strong and resilient, albeit at a more moderate pace than Q3. Recent economic data has been mixed, but perhaps more good than bad. However, the favorable news on inflation from the core PCE deflator gives the FOMC leeway to begin an easing cycle in coming months, most likely in May or June. Once the Fed actually starts cutting rates, the longer end of the yield curve 10 years and out tends to trade well. With the recent back-up in rates, we will look to add some duration back into the portfolio in anticipation.
Corporate Bond Market Commentary
- U.S. High Yield tightened 2 bp last week to an OAS of 354 bp. On a total return basis, HY declined -0.5% on broad-based negative performance from BBs (-0.6%), Bs (-0.5%) and CCCs (-0.4%). On a YTD basis, HY is now down -0.7% with CCCs (-1.1%) underperforming Bs (-0.7%) and BBs (-0.6%). US HY primary market activity remained elevated with almost $9 billion of total issuance last week. YTD issuance now totals over $15 billion.
- HY fund flows were +$496 million.
- IG bonds tightened 1bp to +101bp and total returns were -0.93%.
- The IG primary market strength continued with $49.1 billion pricing across 24 issuers, and new issue concessions were a paltry 0.5bp. Fund flows were +$2.16 billion.
Our take: The IG new issue frenzy continued, but the supply is being easily digested and with scant new issue concessions. The fact that IG spreads are tightening in spite of this massive wave of supply is testament to the strength of the market for higher quality fixed income. The HY new issue calendar got a later start and is ramping more slowly. So far, lower quality borrowers have been a greater proportion of the mix, and these deals are getting done easily at pricing well inside of initial price talk. As earnings start to roll in, we would expect issuance from higher quality HY borrowers to increase somewhat, but many of these companies will wait until all-in rates go lower, knowing that the market will remain open for them (as opposed to lower quality companies, where prudence dictates that they issue when the market is wide open). We are opportunistically participating in the new issue market and trading around it, while we await better entry points on yield and spread in the broader market.
Municipal Bond Market Commentary
- For the week ending January 19, high grade tax-exempt municipal bonds yields rose 17, 17, 17 and 14 bps at 2, 5, 10 and 30 years, outperforming US Treasuries across the curve with US Treasury yields rising by 24, 22, 18 and 15 bps at 2, 5, 10 and 30 years.
- AAA Muni/Treasury ratios were steady at 2 and 30 years and cheapened by 1% at 5 and 10 years, ending the week at 64%, 61%, 61% and 84%. AA Muni/AA Corporate ratios were also higher across the curve by 1%, 2%, 3% and 1% at 2, 5, 10 and 30 years, to end the week at 64%, 60%, 57% and 78% respectively.
- For the period ending January 17, municipal bond funds reported inflows of $898 million, with $709 million into open-end funds and $189 million into ETFs.
- The muni new issue calendar is expected to be about $8.77 billion this week.
Our take: The muni markets continue to follow the UST markets, albeit usually in a delayed manner. The most recent selloff has left municipal bond yields at their highest rates since early December. Though ratios rose this week, they remain rich to historical values across the curve. 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 Fed rate cuts. Municipal bond yields remain at levels not seen for a decade until recently.
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