Weekly Fixed Income Commentary (February 14, 2024)
Economic Commentary
- January CPI rose 0.3%, exceeding expectations by a tenth, for a year-on-year increase of 3.1%, two tenths higher than the 2.9% consensus. The core CPI (excluding food and energy) rose 0.4% on the month and 3.9% year-on-year, both exceeding expectations. The reacceleration in monthly data might cause concern among FOMC participants, though the core PCE — which is the Fed’s primary focus — behaved much better than the core CPI in last year’s second half and may continue to do so.
- The biggest contributor to CPI inflation this month was Owners’ Equivalent Rent (OER), which rose 0.6% in January. The rise in shelter costs was unexpected, as many economists and traders believed rents would exert downward pressure on inflation in 2024. The jump in the OER is also reflected in the CPI supercore, which rose 0.9% in January, lifting it to 4.3% year-over year.
- Food also contributed to price increases in January, growing 0.4% over the month. The jump in food prices can be partially attributed to a coast-to-coast winter storm that caused major transportation disruptions.
- The NFIB small business optimism index showed the lowest headline reading since April of last year, a notable contrast to other sentiment surveys that have mostly been on the upswing. The diffusion index for “actual price changes” reached its lowest point since January 2021.
Our take: The hotter-than-expected CPI report has moved market pricing much closer to Fed dot plots. While CPI was strong, there are important differences between how the CPI and the PCE are measured, and PCE is the Fed’s preferred inflation measure. Many businesses undertake big annual one-time price increases in January, especially in services, which can diverge from the seasonal adjustment factors. There were also major weather events during the month which disrupted supply chains and normal commerce, which may further explain some of the increase. However, higher-than-expected inflation is not going to convince a reluctant Fed to cut rates imminently. The stronger data and resulting further delays in starting rate cuts raises the risk that they will either have to snap the market tighter to rein in stronger data, or that the data will be a head-fake, but the Fed will wait too long to cut rates, making the landing harder than expected. Neither of these two risks are currently priced into a fairly complacent market.
Corporate Bond Market Commentary
- US High Yield tightened -14 bp last week to an OAS of +333 bp. On a total return basis, US HY climbed +0.2% on outperformance from CCCs (+0.6%) over Bs (+0.2%) and BBs (flat). On a YTD basis, US HY is +0.2% with CCCs (+0.1%) and BBs (+0.1%) trailing Bs (+0.3%).
- US HY primary markets were active again last week bringing the MTD total to almost $9 billion. YTD issuance now totals almost $40 billion.
- HY fund flows were -$356 million, the first outflow since the first week of January.
- US IG spreads tightened -2bp to +100bp but higher UST yields pushed total return losses to -0.81%.
- New issue supply was $41.8 billion across 22 issuers, well above expectations of $25-30 billion. Order books averaged 3.7x oversubscribed, new issue concessions were only 2.8bp, and almost 40% of deals paid nil to negative new issue concessions. Projections for this week are for $30 billion, including a large M&A-driven deal for BMY.
- IG fund flows were -$720 million.
Our take: The higher-than-expected CPI report shocked rates and created some volatility in the IG and HY markets. We have been anticipating an increase in volatility and have our dry powder and shopping list ready to go. We have begun to nibble on some things at lower prices / higher yields and will continue to buy into weakness.
Municipal Bond Market Commentary
- For the week ending February 9, high grade tax-exempt municipal bond yields rose 10, 9, 9 and 10 bps at 2, 5, 10 and 30 years, outperforming US Treasuries by 2-6 bps across the curve with US Treasury yields rising by 12, 15, 16, and 15 bps at 2, 5, 10 and 30 years.
- AAA Muni/Treasury ratios were unchanged across the curve, ending the week at 62%, 59%, 60% and 84%. AA Muni/AA Corporate ratios were slightly higher by 1%, 2%, and 1% at 2, 5, and 10 years and unchanged at 30 years, to end the week at 61%, 57%, 55% and 76% respectively.
- For the period ending February 7, municipal bond funds reported outflows of $121 million, with $322 million into open-end funds and $443 million out of ETFs.
- The muni new issue calendar is expected to be about $4 billion this week.
Our take: The script remains largely the same, slightly tweaked, as fixed income market yields have risen in response to stronger than expected economic numbers and expectations of the start of a Fed easing cycle getting pushed out on the calendar. Municipal bond yields remain at high nominal levels relative to the last decade and maintain their historical richness to US Treasuries and IG corporates. Mutual fund inflows and reinvestment capital have offset supply thus far in 2024 to maintain the low AAA muni/Treasury ratios. We still expect stronger new issuance to materialize in 2024 and would expect ratios to eventually rise.
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