Weekly Fixed Income Commentary (February 22, 2024)
Economic Commentary
- January PPI rose 0.9% year-on-year. Excluding food and energy, the core PPI rose 0.5%, exceeding expectations by half a percent, for a 2.0% year-on-year increase. Due to challenges with seasonal adjustments, January is often a challenging month for the core PPI. It was the biggest monthly increase last year, and with a 0.8% rise in January 2022, the second biggest increase that year.
- Retail sales came in weaker than expected at -0.8% m/m, after a positive surprise in December. There were chunky declines in auto sales and building materials, which alone accounted for almost 0.6% of the m/m decline.
- FOMC minutes suggest the Fed isn’t close to being ready to cut interest rates. However, they also indicated that the top in rates is behind us, and that the bar to an additional hike is very high. Officials are also readying a discussion of slowing the pace that it shrinks its asset portfolio.
Our take: Recent PPI data on the heels of strong CPI readings is fueling fears of reacceleration of inflation. Yet weak January retail sales are being shaken-off due to extreme weather in January across much of the country. Well, why were non-store (online) sales also weak in January? Presumably, if people couldn’t go outside, they might shift to more online shopping. We have been saying the Fed is more worried about the reacceleration of inflation versus overtightening and causing a slowing economy in their calculus of risk management, and this is why we have moved the portfolio up in quality but also hedge rates. When market pricing comes around to 3 or fewer cuts in 2024, then we will get more aggressive on adding duration.
Corporate Bond Market Commentary
- US High Yield widened 1 bp last week to an OAS of 334 bp. On a total return basis, US HY declined -0.4% on broad-based negative performance from BBs (-0.4%), Bs (-0.4%) and CCCs (-0.3%). On a YTD basis, US HY is down -0.2% with CCCs (-0.2%) and BBs (-0.3%) trailing Bs (-0.1%).
- Fund flows were -$136 million.
- US HY primary markets were active again last week, bringing the MTD total to ~$19 billion. YTD issuance now totals ~$40 billion.
- IG spreads tightened 4bp but higher treasury yields pushed IG total returns down -0.45%.
- The IG primary market was active again, pricing $37 billion, slightly below expectations of $40-45 billion. Order books averaged 4.7x oversubscribed, and new issue concessions (NIC) averaged 3.4 bps.
- Fund flows into IG were +$1.594 billion.
Our take: Corporate bond markets have been relatively resilient so far this year, with spread tightening partially offsetting higher rates. Issuance has been heavy, particularly in IG and lower-rated HY. We have been active in the new-issue market to enhance returns and have nibbled on bonds on our shopping list as rates have moved higher. If or when 10yr UST rates approach 4.5% we expect to be more aggressive on adding duration to the portfolio.
Municipal Bond Market Commentary
- For the week ending February 16, high grade tax-exempt municipal bonds yields rose a nearly parallel 4, 4, 4 and 5 bps at 2, 5, 10 and 30 years, outperforming US Treasuries across the curve with US Treasury yields rising by 16, 14, 10, and 6 bps at 2, 5, 10 and 30 years.
- AAA Muni/Treasury ratios were slightly richer on the short end of the curve, down 1% at 2 and 5 years and unchanged at 10 and 30 years, ending the week at 61%, 58%, 60% and 84% at 2, 5, 10 and 30 years. AA Muni/AA Corporate ratios were unchanged to end the week at 61%, 57%, 55% and 76% respectively.
- For the period ending February 14, municipal bond funds reported outflows of $142 million.
- The muni new issue calendar is expected to be about $5.3 billion this week.
Our take: Bond yields continue to drift higher, but the muni market has steadily outperformed US Treasuries thus far in 2024. Between 1/31/23 and 2/15/24, the US Treasury 10-year yields rose 37 bps from 3.91% to 4.28%. Over the same period, the Bloomberg AAA municipal bond yield only rose 9 bps, from 2.46% to 2.55%. Net supply is still expected to turn positive and put upward pressure on AAA Muni/US Treasury ratios, but it is yet to materialize and warrants close attention to the upcoming new issuance calendar. Though the ratios remain relatively very rich, nominal muni yields are still high relative to the last decade.
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