Weekly Fixed Income Commentary (August 15, 2024)
Economic Commentary
- In July, headline CPI rose 0.155%, in line with the consensus estimate of 0.2% and good for a 2.9% year-on-year increase. The core CPI rose 0.165%, also in line with expectations and good for a 3.2% annual increase. The 3-month annualized Core CPI is down to 1.6%, the lowest since early 2021.
- The BLS notes in the CPI release that “the index for shelter rose 0.4% in July, accounting for nearly 90 percent of the monthly increase in the all-items index.” The Fed’s preferred PCE price index places less weight on shelter than the CPI, meaning the July PCE could be lower than the CPI.
- The Producer Price Index, which measures the prices that businesses receive for their goods and services, rose by a milder-than-expected 0.1% in July from a month earlier, compared to expectations for a rise of 0.2%. From a year earlier, the PPI increased 2.2%, the smallest year-over-year increase since March.
- Retail sales rose 1.0%, well ahead of expectations of +0.4%. Control group sales increased +0.3%, ahead of expectations of +0.1%. The gains were fairly broad-based and indicate the consumer is not quite tapped out yet.
Our take: July PPI showed some modest acceleration in input costs for goods, but this has not passed through (yet) to consumers in CPI, perhaps because consumers are less confident or less able to pay higher prices. If this trend were to hold, it would portend margin contraction for companies, which would eventually trigger layoffs and other cost cuts to protect and maintain margins going forward. This is how modest job losses turn into a more severe labor market correction and require more significant rate cuts by the Fed. In the meantime, the data should keep us on track for a 25bp cut in September. This was pretty well cemented by the retail sales data. A 50bp cut is arguably not warranted, and recent FOMC speakers underscore that they are not even fully ready for 25 let alone 50bp. Use any pullback in yields from strong retail sales and the move away from any notion of a 50bp cut in September to add to duration, as the medium-term move will be lower in rates.
Corporate Bond Market Commentary
- IG spreads rebounded modestly and tightened 1bp to +105bp but higher yields drove total returns of -0.77%.
- IG new issue supply was a robust $45 billion.
- IG fund flows were +$1.339 billion.
- HY spreads tightened 23bp to +349bp and total returns were +0.30% driven by CCCs (+0.55%), BBs (+0.26%) and Bs (+0.26%).
- HY fund flows were -$2.165 billion.
- HY new issuance was $7 billion.
- Loan fund outflows were -$3.1 billion, as investors move from floating rate product to fixed rate duration in anticipation of rate cuts.
Our take: : Bond market performance has been strong of late on lower rates and favorable supply/demand technical conditions. As we now enter peak vacation season and the lack of trading liquidity that comes along with it, moves will be exacerbated. Corporate earnings season is largely complete, so the individual name news flow should be quieter, with more of a focus on macro and broader market moves. Jerome Powell’s Jackson Hole speech at the end of next week could be a source of volatility. If things get a little sloppy over the next two weeks, we plan to take advantage and buy some cheap bonds in anticipation of the wave of fund flows that should come into bond funds once the Fed actually cuts rates in September.
Municipal Bond Market Commentary
- Yields moved higher in both US Treasuries and municipals for the week ending August 9. AAA muni yields were up 0, 3, 8 and 11 bps at 2, 5, 10 and 30 years. The AAA municipal bond curve outperformed US Treasuries across the curve, with US Treasury yields rising 17, 18, 15, and 11 bps at 2, 5, 10 and 30 years.
- AAA Muni/Treasury ratios fell 3% at 2 and 5 years, 1% at 10 years and remained steady at 30 years to end the week at 66%, 69%, 68% and 86%. AA Muni/AA Corporate ratios fell 1% at 2 and 5 years, rose 1% at 10 years and remained flat at 30 years to end the week at 63%, 64%, 64% and 78% at 2, 5, 10 and 30 years.
- For the period ending August 7 municipal bond funds had inflows of $968 million, $392 million to open-end funds and $576 million to ETFs.
- The muni new issue calendar is expected to be around $8.7 billion this week.
Our take: As expected, based on the normal lag and catchup of muni markets, they did outperform US Treasuries over the last week. Yields have moved significantly in the last three weeks and the market seems to be tightly wound, with daily volatility greater than the catalysts would call for. This may well continue until the September FOMC meeting where the market is currently predicting 100% probability of at least a 25 bp cut in rates.
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