Weekly Fixed Income Commentary (December 26, 2024)
Economic Commentary
- PCE price indices rose 0.1%, headline and core, in November. Both were lower than expected. The core PCE year-on-year stayed at 2.8%.
- Core PCE prices have risen at an annualized 2.5% over the past three months, a bit above the 2.3% seen over the prior three months but below the year-on-year rate of 2.8% and therefore still consistent with ongoing disinflation. The Dallas Fed’s trimmed-mean PCE inflation rate—a good statistical measure of the underlying trend—ran at an annualized 2.4% over the past three months and just 1.8% in November. And with labor market looseness back to 2017 levels, FHN’s wage tracker has slowed to 3.9% year-on-year, now inside the 3.5-4% range consistent with 2% price inflation if productivity grows 1.5-2% in coming years.
- Personal income rose +0.3% and personal spending rose +0.4%, continuing the trend of consumers spending more than their income.
- The University of Michigan inflation expectations remain well-anchored, with 1-year declining from 2.9% to 2.8%, and 5-10 years from 3.1% to 3.0%.
- Durable goods orders were down -1.1%, below expectations of -0.3%. Excluding transportation, orders were down -0.1% versus expectations of +0.3%.
- The conference board consumer confidence slumped 8.1 points to 104.7, well below expectations of 113.2. Most of the slump was in expectations, down from 92.3 to 81.1.
- Redbook US same-store sales are up 5% through the first three weeks of December.
- Initial jobless claims were 219k, down 1k from last week and slightly below the 223k estimate. Continuing claims rose from a revised 1864k to 1910k, above the 1881k estimate, and have reached the highest level in three years.
Our take: The prevailing consensus is that the economy remains strong, the labor market is softening a bit but remains healthy, inflation is stuck and perhaps rising again, and everything the new administration does in 2025 and beyond will be inflationary, making intermediate and longer-dated treasury bonds undesirable if not toxic. Some or all of these expectations may prove correct, but we see the potential for a contrarian view. The economy has been strong largely on account of fiscal stimulus, which is now waning, consumers spending above their incomes draining down the savings rate, and the wealth effect of rising stock and home prices, which are susceptible to the recent large spike in interest rates. The labor market is cooling, as evidenced by several measures including job openings and declining quits, rising continuing claims, softer wage growth etc. If corporate profit margins contract from consumers balking at higher prices, job cuts will inevitably follow. Inflation has trended sideways over the last few months, and while it may remain stuck or re-accelerate, there are plausible reasons why it might begin to decline again in 2025 as labor costs are at levels which should not be inflationary, and higher rates should further cool rate-sensitive portions of the economy. Lastly, the incoming administration has several articulated policy goals; let’s see how they prioritize them and how effective they are in getting them enacted given the very narrow majority in congress. It is not a given that rates remain high or even go higher. The terminal rate and term premium are theoretical; at some point a real-world reason to buy Treasuries could supersede academic arguments. Our mandate is to actively and continuously assess all of these factors and adjust accordingly. We plan to trade the range and be on the lookout for the appropriate timing and amount of contrarian positioning.
Corporate Bond Market Commentary
- Investment grade spreads widened 4bp to +82bp and total returns were -0.93%. YTD returns for AAAs are now negative.
- Fund inflows were $927 million.
- There was no new issue supply last week and no further supply expected through year-end.
- High yield bond spreads were 18bp wider to +286bp. Total returns were -0.74% (BBs -0.79%, Bs -0.72% and CCCs -0.62%).
- HY fund outflows were -$1.136 billion.
- $625 million of new issuance priced last week, the final gasp before year end.
Our take: With the recent rise in yields, even more of 2024’s strong performance in the high yield market is attributable to CCCs. Expecting CCCs to outperform again in 2025 would make three years in a row, which would be unusual by historical standards. BBs are now yielding over 6.5% and Bs over 7.5%, offering attractive return potential, especially for those managers who can avoid land mines through fundamental credit analysis. In addition, these higher yields offer cushion to use a modest portion as a budget for tactical hedges and/or credit shorts to protect against a blowout in spreads while still offering solid potential returns in the year ahead.
Municipal Bond Market Commentary
- The week ending December 20, the last full week of open markets in 2024, saw bonds sell off across the curve. AAA muni yields were up 19, 21, 22, and 25 bp at 2, 5, 10 and 30 years while US Treasury yields were up 7, 13, 13, and 12 bp at 2, 5, 10 and 30 years.
- AAA Muni/Treasury ratios were up 3% across the curve to end the week at 65%, 66%, 69% and 82%. AA Muni/AA Corporate ratios were up 5%, 3%, 2% and 2% at 2, 5, 10 and 30 years to end the week at 68%, 65%, 65% and 78% at 2, 5, 10 and 30 years.
- For the period ending December 18 municipal bond funds had outflows of $857 million.
- Muni issuance is expected to be less than $1 billion in this holiday shortened week.
Our take: Bonds sold off substantially after the FOMC meeting as the Fed appeared to take a more hawkish stance. We expect continued rate volatility over the near term as participants try to read the tea leaves of Fed monetary policy, uncertainty about the Trump administration’s fiscal policies and whether he’ll be successful in getting Republican support, and multiple ongoing conflicts across the world. Though the ratios jumped in the last week, municipal bond relative value technicals continue to be favorable, with negative net supply and very strong fund flows over the last 6 months that will likely return.
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