Weekly Fixed Income Commentary (January 30, 2025)
Economic Commentary
- The FT noted over the weekend a point that we have been making here for some time; after the recent rally, the equity risk premium continues to be negative and sits at the lowest level since the 2002 dot.com bust.
- The recent release of DeepSeek AI appears to have harnessed the power of ChatGPT using tremendously less energy and fewer microchips. This has significant implications for US AI companies that create downstream effects on the bond market. First, the risk-off behavior from the volatility and selling of AI-related companies produced a flight to quality that buoyed Treasury prices and lowered yields. Second, DeepSeek’s apparent efficiency suggests much less capital spending and power demand is needed to fulfill the promises of AI, which could reduce future inflationary pressures and lower rates. American firms had previously said advancing AI to the next phase would require hundreds of billions of dollars in investment, in large part because of the resource demands.
- Real GDP grew 2.3% in the fourth quarter at a quarterly annualized rate. The consensus expectation was 2.6%, but most of the estimates submitted to Bloomberg were before yesterday’s December trade and inventory data. The Atlanta Fed’s estimate of 2.3% was spot-on. The downside miss to headline growth mostly reflected a huge drawdown in inventories. Personal consumption growth of 4.2% was well above the consensus estimate of 3.2%.
- December durable goods orders of -2.2% were weaker than expected because civilian aircraft orders fell 45.7%. Boeing had just reported December orders had increased the most in a year, but the orders surge was overmatched by a surge in cancelations, and the durable goods report reflects net new orders.
- The S&P Global Composite PMI on Friday missed estimates due to a downside miss by the services PMI. The composite fell three points to 52.4, missing expectations of 55.6, and the services PMI fell four points to 52.8, missing estimates of 56.5. The manufacturing PMI jumped 0.7 points to 50.1, beating the estimate of 49.8. The services index showed the slowest growth since April of 2024, but there was still plenty of optimism in the survey.
- University of Michigan consumer sentiment of 71.1 was down from 73.2 last month and below the 73.2 estimate.
- Core PCE prices rose 2.5% in the quarter, as expected. This is the Fed’s preferred inflation metric and confirms analyst estimates for a moderate December print. The GDP Price index, which looks at all prices factoring into GDP data and not just personal consumption prices, rose only 2.2% versus a consensus expectation for 2.5%.
- Yesterday’s FOMC statement and press conference were non-events, as many expected they would be. The target fed funds rate remains unchanged at 4.25%-4.50%. The bond market initially sold off after the removal of “[inflation] has made progress toward the Committee’s 2 percent objective” from the policy statement, but pared losses once Chair Powell clarified the change was just “language cleanup.” The Fed will remain data-dependent in making policy decisions.
Our take: There is a tremendous amount of noise in the data that will take some time for clarity to replace obfuscation. The economy was strong in Q4, driven again by seemingly above-trend and unsustainably high consumer spending. Can this last in the face of persistent inflation, less confidence in the labor market, and uncertainty around tariffs and other policy changes? The labor market is at best static, but more likely is slowing down. This would normally beget caution on the part of consumers, but in this case, it seems like consumers, and businesses, were stocking up on things before tariffs might get put in place. Let’s see what the hangover is from this front-running spending spree over the coming weeks and months. The Fed is on hold for now as well, waiting for clarity on these aforementioned trends and the implementation of policies by the new administration. Rates may be rangebound for a bit until the fog begins to lift.
Corporate Bond Market Commentary
- IG spreads tightened 2bp last week to +80bp. Total returns were +0.24%.
- Twelve IG borrowers priced $22.4 billion of new issue supply in the holiday-shortened week. New issue concessions were less than 1bp, book coverage was 3.1x and the attrition rate was only 18%.
- Fund flows were -$1 million.
- HY spreads tightened 4bp to +264bp. Total returns were +0.34% (BBs +0.27%, Bs +0.36%, CCCs +0.59%)
- New issuance was only $1.19 billion last week but is starting to pick up this week.
Our take: Corporate bonds handled the DeepSeek volatility well, with spreads holding-in and rates lower. This is a good reminder that at a time when the equity risk premium is negative – the risk/reward strongly favors owning high-quality bonds – for income, diversification, and volatility diminution. For active managers with the willingness and ability to find winners and avoid losers among the volatility, capital appreciation is the cherry on top.
Municipal Bond Market Commentary
- The week ending January 24 saw yields falling in both municipal and US Treasury bonds. AAA muni yields were down 5, 6, 5, and 2 bp at 2, 5, 10 and 30 years while US Treasury yields were down 2, 1, 1, and 1 bp at 2, 5, 10 and 30 years.
- AAA Muni/Treasury ratios were down 1% at 2 years, down 2% at 5 years, down 1% at 10 years, and unchanged at 30 years to end the week at 65%, 65%, 68% and 83%. AA Muni/AA Corporate ratios were down 2% at 2 and 5 years, down 3% at 10 years, and unchanged at 30 years to end the week at 65%, 63%, 63% and 77% at 2, 5, 10 and 30 years.
- Municipal bond funds had strong inflows of $2 billion for the weekly period ending January 22.
- Muni issuance is expected to be around $5.6 billion this week, a smaller than usual calendar due to the FOMC meeting.
Our take: Brokers report a strong two-way flow in municipal trading, with demand supported by muni yields that remain close to their 12-month highs and a negative net supply forecast through February.
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