Weekly Fixed Income Commentary (May 2, 2024)
Economic Commentary
- A bigger-than-expected 1.2% rise in the employment cost index is one more reason for the Fed to wait before cutting rates. Compensation rose 4.2% year-on-year, the same as in the fourth quarter.
- Consumer confidence fell to its second-lowest headline reading since February 2021.
- The April ISM Manufacturing index fell from 50.3 to 49.2, below the 50.0 consensus expectation. Upward momentum since the middle of 2023 had stalled in February, and now again in April, but the trend since November 2023 is decidedly upward. An unexpected jump in the prices paid component from 55.8 to 60.9 in April could be cause for concern, especially since it marks the fourth consecutive month of the index being above 50, which signals accelerating prices.
- Job openings fell to 8.48 million, and the ratio of job openings to job seekers of 1.32 continues to decline, suggesting some softening in the labor market.
- The Q1 Employment Cost Index accelerated from 0.9% to 1.2%, above the 1.0% expectation
- Treasury published its financing estimates for the next three months, with $243 billion, $41 billion higher than the estimate for this period made 3 months ago.
- Productivity came in at a disappointing 0.3%, which pushed unit labor costs up to 4.7%.
- The FOMC left rates unchanged, while Chair Powell signaled less confidence in the progress towards 2% inflation and a patience to leave rates higher for longer to achieve their objectives.
Our take: A lot of economic data combined with the FOMC meeting gives traders much to ponder. While the FOMC meeting and Powell’s presser were not quite as hawkish as they could have been, the market had already moved quite a bit in the weeks leading up. From here, despite Powell’s hope or belief that easing financial conditions are not to blame for stalled progress, the economy and the labor market necessarily have to slow in order to achieve the objectives. How much they slow will depend on how patient they are willing to be, but also whether policy error due to lags and lack of precision cause downside shocks. Rates have moved into a reasonable range, where we expect they will reside for some period of time between 4.5% to 5.0% for the time being, before eventually heading lower when the economy slows, one way or another. Adding a bit more duration to portfolios is prudent.
Corporate Bond Market Commentary
- IG spreads tightened 4bp to +90 and total returns were essentially flat at +0.01%.
- Primary markets only priced $11.6 billion. Order books averaged 3.1x oversubscribed and NICs were 4bp.
- Fund flows were -$330 million.
- HY spreads tightened 21bp to +316bp and total returns were +0.63%.
- HY supply was $3.5 billion.
- Fund flows were +$235 million.
Our take: Corporate bonds continue to be resilient in the face of a rise in rates. Spreads continue to be tight, but all-in yields are more justifiable. We have nibbled a bit more on quality bonds recently as yields rose and prices softened but remain poised with dry powder and a shopping list for more opportunities as they present themselves. The lower-end consumer is clearly suffering, and recent earnings results from consumer discretionary companies such as Starbucks, McDonald’s, Yum Brands, and others flash a warning to avoid bonds of lower-rated companies dependent on that cohort of consumers.
Municipal Bond Market Commentary
- For the week ending April 26, yields continued their upward trajectory with AAA tax-exempt municipal bond yields rising 6, 7, 6, and 5 bps at 2, 5, 10 and 30 years, underperforming US Treasuries slightly at all but the 30-year tenor. US Treasury yields were up 1, 2, 4 and 6 bps at 2, 5, 10 and 30 years.
- AAA Muni/Treasury ratios were up 2% at 2 years, 1% at 5 and 10 years and unchanged at 30 years, ending the week at 66%, 60%, 60% and 84%. AA Muni/AA Corporate ratios were up 1%, 2%, 2% and 1% to end the week at 65%, 60%, 58% and 77% respectively.
- For the weekly period ending April 24, municipal bond open end funds reported outflows of $387 million but those were more than offset by ETF reported inflows of $588 million.
- The muni new issue calendar is expected to be $6.5 billion this week.
Our take: US Treasury and municipal bond yields continued slightly higher but seem to have found at least a short-term trading range. The muni market will likely just follow the US Treasury market over the near term, which is in turn closely watching economic releases for indications of future levels of economic growth and inflation. The market timeline for the Federal Reserve easing cycle is still only predicting one 25 bp cut in 2024, but it has moved from December up to September. Municipal bonds are rich relative to US Treasuries and that looks likely to remain the case as most analysts are predicting favorable technical support for municipals over the Summer months.
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