Weekly Fixed Income Commentary (February 8, 2024)
Economic Commentary
- January nonfarm payrolls rose a much-stronger-than-expected 353k, nearly double the consensus of 185K. There was also a significant 135k upward revision to the prior two months.
- Average hourly earnings rose 0.6%, double the consensus, 0.3%, although it appears that this is a statistical anomaly that will reverse next month.
- The January ISM services index jumped 53.4 from 50.5, comfortably above the consensus of 52.0. More alarming is the jump in the prices paid index, to 64.0 from 57.4. This is the highest reading since February 2023, and the biggest monthly increase since 2012.
- The Senior Loan Officers Survey (SLOOS) showed banks continue to tighten loan standards but at a far less aggressive pace. The peak in the number of banks tightening standards was two quarters ago.
Our take: Recent stronger-than-expected economic data and Fed speakers continuing to push back on near-term rate cuts pushed yields higher for a few days, where they have now found a level. The biggest 10yr UST auction ever went smoothly yesterday, clearing a technical hurdle. We continue to believe that the precise timing of the first interest rate cut is less important for the intermediate to longer portion of the yield curve, but the longer the Fed waits to start cutting, the greater the risk of an overcorrection causing a bumpier-than-necessary landing and/or unintended consequences. The pending adjustment to the Fed’s balance sheet reduction program is also a bullish factor for the long end of the yield curve because the Fed’s will again be a big, price agnostic, steady buyer across the curve, and this will likely start before the first rate cut.
Corporate Bond Market Commentary
- US High Yield widened 8 bp last week to an OAS of +347 bp. On a total return basis, US HY climbed +0.1% on outperformance from BBs (+0.1%) over Bs (flat) and CCCs (-0.1%). On a YTD basis, US HY is flattish with CCCs (-0.5%) underperforming Bs (+0.1%) and BBs (+0.1%).
- US HY primary market activity was elevated again last week with roughly $12 billion of total volume.
- HY fund flows were +$2.98 billion.
- IG spreads widened 5bp to +102bp, but lower UST yields boosted weekly IG total returns to +0.53%.
- IG issuance was $21.5 billion and mostly front-loaded in the early part of the week before the FOMC meeting. Fund flows were -$1.44 billion, the first net outflow since early December.
Our take: Constructive technicals from continued inflows, high fund cash balances, and new issuance that is picking up but below expected levels are supporting the HY market in the face of rate volatility and earnings uncertainty. All-in yields for higher quality HY bonds are compelling as long as the economy avoids a hard landing. For IG bonds, performance should be supported by strong fund flows from institutional asset allocators expecting lower interest rates and seeking higher quality duration. 2024 will be a good year for corporate bonds overall, but there will be rate volatility, dispersion, and idiosyncratic events, both good and bad. Nimble and tactical adjustments will be key for alpha generation.
Municipal Bond Market Commentary
- For the week ending February 2, high grade tax-exempt municipal bonds yields fell 15, 15, 13 and 13 bps at 2, 5, 10 and 30 years, outperforming US Treasuries from 2-10 years and slightly underperforming in 30 years, with US Treasury yields rising by 1 bp at 2 years and falling by 5, 12 and 15 bps at 5, 10 and 30 years.
- AAA Muni/Treasury ratios were 3% lower at 2 and 5 years, 2% lower at 10 years, and unchanged at 30 years, ending the week at 62%, 59%, 60% and 84%. AA Muni/AA Corporate ratios were lower across the curve, 3%, 4%, 3% and 2% at 2, 5, 10 and 30 years, to end the week at 60%, 55%, 54% and 76% respectively.
- For the period ending January 31, municipal bond funds reported inflows of $1.5 billion, with $659 million into open-end funds and $817 million into ETFs.
- The muni new issue calendar is expected to be about $9 billion this week.
Our take: Little change to the market dynamics over the last week as muni markets continue to follow the UST markets and all fixed income markets try to predict the timing of the Federal Reserve easing cycle. Municipal bond yields remain at high nominal levels relative to the last decade, but they’re also historically rich to US Treasuries and IG corporates. Strong fund inflows and reinvestment capital have offset elevated supply thus far in 2024 to maintain the low AAA Muni/Treasury ratios. We expect stronger new issuance in 2024 and would expect ratios to eventually rise unless the new issuance continues to be offset by fund inflows.
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