Weekly Fixed Income Commentary (March, 2025)
Economic Commentary
- Yields on 10-year German bunds rose 30bp yesterday, the largest daily gain since 1990. Fiscal guardrails are being lowered to allow higher spending on defense and other infrastructure projects that are expected to be stimulative. German political leaders are encouraging the EU to change its debt rules so other countries can have more fiscal flexibility. The expected increase in European bond issuance is lifting yields worldwide, including Japan, where yields reached multi-decade highs. Germany would be spending 500 billion euros on a special defense fund, some of which would be exempt from EU limits on sovereign deficits. Rising supply for a safe credit like German bunds flows downstream to the Treasury market.
- The Institute for Supply Management noted in the release that all four subindexes that feed into the headline index (Business Activity, Employment, New Orders, and Supplier Deliveries) were in expansionary territory for the third month in a row. That has not happened since May of 2022. Additionally, fourteen services industries (out of seventeen surveyed) reported growth in the month. The headline index rose from 52.8 in January to 53.5 in February, above the consensus estimate of 52.5. Employment and new orders rose to 53.9 and 52.2, respectively. Both were above estimates, particularly employment. The prices paid component was expected to be unchanged at 60.4, but the series rose to 62.6 as firms likely anticipate higher input prices from tariffs.
- Initial jobless claims rose from 220k to 242k in the week ending February 22, but the 4-week average remains low. State-level claims did not point to any DOGE-related explanation for yesterday’s rise in claims.
- January PCE inflation rose 0.3%, as expected, resulting in annualized inflation rates of 2.5% and 2.6%, headline and core, again as expected.
- Unit labor costs rose only 2.2%, below the 3% estimate and the 3% reading in Q3, a further indication that labor costs are not likely to be a contributor to inflation.
Our take: The noise and volatility in the economic data right now is highly elevated, as we have been expecting it to be. Trade policy is changing by the hour. DOGE spending cuts have begun in earnest but may or may not be as much as headline figures suggest and some may be halted by court decisions. The more stimulative aspects of the new administration’s policies such as tax cut extensions and reduced regulation have not yet been enacted or have not yet begun to impact the real-world economy. Our concern is that all of the uncertainty will cause decision makers, both individual consumers and corporate management teams, to hesitate and pause or cut back on spending and investment. Recent commentary from retailers suggests this is in fact happening in real time. Ordinarily, this would portend lower rates. However, at the same time, Germany and the rest of Europe are undertaking a massive pivot from fiscal conservatism to aggressive defense and other spending, sending EU rates sharply higher, and the question becomes can the US be an island of lower rates if global rates are pushing higher? Active management is better equipped to adjust to all the changes in both rates and economic activity.
Corporate Bond Market Commentary
- Investment grade bond spreads widened 7bp last week to +88bp but sharply lower UST yields drove IG total returns +1.05%.
- $51 billion of new issue supply priced last week, and this current week is even higher with the jumbo Mars transaction. Order books declined to 3.1x, new issue concessions rose modestly to 4bp, and attrition rose slightly to 26%.
- Fund flows were only +$95 million.
- High yield bond spreads widened 9bp last week to +287bp and total returns were +0.42% (+0.48% BBs, +0.35% Bs, +0.34% CCCs).
- New issue supply was only $1.9 billion, and year-to-date total of $40.7 billion is below forecasts which were driven by optimistic sentiment for more activity under the new administration.
- Fund flows were a robust $1.455 billion, a second consecutive sizeable weekly inflow.
Our take: Daily gyrations present challenge but also opportunities by increasing the likelihood that sentiment and technical factors will cause individual bonds to be mispriced. In addition, the active investment grade new issue calendar offers daily chances to generate trading gains. This should be fertile ground for active managers who do fundamental credit research to discern winners and losers, or babies from bath water.
Municipal Bond Market Commentary
- Muni and US Treasury yields continued to drop over the week ending February 28. AAA muni yields were down 8, 9, 10, and 6 bp at 2, 5, 10 and 30 years while US Treasury yields were down 21, 25, 22, and 19 bp at 2, 5,10 and 30 years.
- AAA Muni/Treasury ratios moved higher, up 1% at 2 and 10 years and up 2% at 5 and 30 years to end the week at 64%, 66%, 68% and 87% at 2,5,10 and 30 years. AA Muni/AA Corporate ratios were down 1% at 2 years, unchanged at 5 and 10 years, and up 2% at 30 years to end the week at 63%, 62%, 63% and 81% at 2, 5, 10 and 30 years.
- Municipal bond funds had inflows of $785 million for the weekly period ending February 26.
- Muni issuance is expected to be around $9.9 billion this week.
Our take: Positive fund inflows continue to support the rich relative value of municipal bonds, but this could be challenged over the next several months as reinvestment dollars drop seasonally. Day to day volatility in the municipal market is being driven primarily by the volatility in the benchmark US Treasury market.
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