Weekly Fixed Income Commentary (June 13, 2024)
Economic Commentary
- Nonfarm payrolls rose 275k in May, 95k more than expected. April was revised down 10k from 175k to 165k, while March was revised down 5k from 315k to 310k, a net revision of -15k. Three-month average job growth was a respectable 250k.
- Average hourly earnings rose 0.4% to $34.91 an hour in May and rose from 4.0% to 4.1% year-on-year. The California food-worker minimum wage increase likely had a role in the bigger-than-expected rise.
- The 0.2 percentage point decline in the labor force participation rate mostly reflected lower participation from those 16-24 years old, a group that tends to change their workforce status around graduation time, at least temporarily, as they transition into the next phase of their working careers. They are also the group most likely to be among those laid off by California fast-food restaurants in the wake of the recent minimum wage hike.
- In the household survey, employment fell 408k and the labor force fell 250k, resulting in a new two-year high in the unemployment rate of 4.0%. To three digits, the rate increased from 3.865% to 3.964%.
- The headline CPI was unchanged (0.006%), the lowest since June 2022. The core rose two tenths (actually 0.163%). Both were a tenth better than expected. The year-on-year inflation rate dropped from 3.36% to 3.27%, the lowest since January’s 3.09%, while the core dropped from 3.61% to 3.42%. Core inflation year-to-date dropped from 4.3% to 3.8%. Core ex-housing was negative for the first time since 2021. The magnitude of the drop in the year-to-date rate underscores how May is the first month this year to bring unquestionably good news on the inflation front. April was cheered because it was as expected, despite being too high to be consistent with 2% inflation. May was not only better-than-expected, it annualizes to 2.0% and is actually consistent with the Fed’s goals.
- For the first time since December, there is so much good news in this inflation report it is hard to know where to begin. For starters, the monthly core increase annualizes to 2.0%. In itself, that’s encouraging. Then there is the broad-based nature of the improvement, with declines in the price of energy, new and used vehicles, recreational goods and services, and many others. There was even a drop of 0.1% in car insurance premiums, which is saying something considering the 20.3% increase in the past year.
- In March there were three cuts in ’24 and three in ’25. Now there is one cut in ’24 and four in ’25. One fewer in the two years combined. The distribution of dots of 2024 dots is interesting. More participants expect to cut twice than once, but no one expects to cut more than twice, while four don’t expect to cut at all this year. So, a plurality favor two cuts, but the median is for one.
- Headline producer prices fell 0.2% in May, reinforcing yesterday’s stellar CPI report and bolstering traders’ assessment of September rate cut odds. Despite producer deflation in May, year-on-year headline PPI inflation was unchanged from the 2.2% April increase reported last month, though it did drop from the revised 2.3% April increase reported this morning. The core PPI (ex-food, energy, and trade services) was unchanged on the month, and up 3.2% year-on-year, the same as in April. May’s core PPI was the lowest since the UAW strike in October, and comes on the heels of the first unchanged CPI since July 2022.
- The core PPI remained stubbornly above 3% in May, rising by a tenth from April’s original 3.1% increase. Nevertheless, after several months of moving in the wrong direction, both CPI and PPI moved in the right direction in May and, combined, point to a very friendly 0.1% increase in the core CPE deflator later this month.
Our take: A plethora of important economic data points over the last week began with stronger than expected payrolls last Friday, a calm before the storm on Monday and Tuesday, and then broad based weaker than expected CPI, PPI and jobless claims flipped the narrative. The Federal Reserve dot plots may have indicated only 1 cut this year, but Jerome Powell plainly admitted that the dots are only as good as the individual economic forecasts, which is to say not very reliable given the dynamism in the underlying statistics. Markets have moved to a 2/3 probability of a September cut, and approximately 2 total cuts in 2024, which feels about right given recent data points. Whether May data is the inflection point to another leg down in cooling prices, or yet another anomaly, we won’t know for sure for a few more months. We may be rangebound on Treasuries, but the range has likely shifted lower for the foreseeable future and high-quality duration should continue to do well.
Corporate Bond Market Commentary
- IG spreads widened 2bp last week to +90, while falling interest rates propelled total returns of +0.36%.
- $33 billion of issuance across 32 borrowers was the busiest week by numerosity since early May. Deals were 2.9x oversubscribed, and NICs were 7bp, above the 4bp average of the previous week.
- Fund flows were +$1.525 billion
- HY spreads tightened 5bp to +315bp and total returns were +0.4%.
- Fund flows were +2.196 billion.
- A robust $8.55 billion of new issues priced.
Our take: Corporate bond markets grinded higher last week and then accelerated this week on the significant move lower in rates. Our tactical strategy of higher quality duration (IG and strong BBs), catalyst-driven trades, and select Bs/CCCs where we see value in underappreciated, out-of-favor, or otherwise mispriced bonds, continues to be a recipe for future success. The solid positive carry from interest income and further tailwind from lower rates bolsters the total return opportunity in actively managed fixed income.
Municipal Bond Market Commentary
- The week ending June 7 saw US Treasury and Muni yields grinding lower only to retrace about half the move on stronger than expected monthly nonfarm payroll numbers at the end of the week. AAA muni yields were 13, 14, 17 and 14 bps lower at 2, 5, 10, and 30 years. The AAA municipal bond curve outperformed the US Treasuries where yields rose 1 bp at 2 year, and fell 4, 6, and 9 bps at 5, 10 and 30 years.
- AAA Muni/Treasury ratios fell across the curve, 3%, 3%, 3% and 1% at 2,5, 10, and 30 years, to end the week at 66%, 67%, 66% and 85% respectively. AA Muni/AA Corporate ratios also fell, 4% at 2 and 5 years, 3% at 10 years and 2% at 30 years, ending the week at 65%, 64%, 62% and 77% at 2, 5, 10 and 30 years.
- For the weekly period ending June 5, Lipper reported municipal bond fund inflows of $289 million to open end funds and $260 million to ETFs.
- Due to the FOMC meeting, a smaller muni new issue calendar of $7.6 billion is expected this week
Our take: The US Treasury and muni markets haven’t definitively broken out of their recent trading range, but with the Fed being “data dependent” and better than expected recent inflation data, both are now trading at the low yields of the recent range. The economic calendar is light the next couple of weeks, with the next major numbers being GDP and PCE at month end, so it’s likely that market technicals and Fed speakers will be the primary short-term drivers of market direction. Though the ratios fell this week, we expect continued upward pressure on US Treasury/AAA muni ratios as large muni new issuance calendars are anticipated to resume after this week’s temporary lull.
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