Weekly Fixed Income Commentary (February 1, 2023)
Corporate Bond Market Commentary
- IG credit spreads narrowed 4 bps this past week to 119 bps on account of better-than-expected US economic data , while IG yields were unchanged at 5.0%. Total return was +0.2%.
- HY credit spreads narrowed 11 bps this past week to 413 bps and yields declined 8 bps WoW to 8.1%. This generated a total return of 0.4% for the week and extended YTD gains to 3.9%. Across ratings, CCCs outperformed once again with a total return gain of 0.8% (+5.9% YTD), while BBs continued to lag but still generated 0.3% WoW (+3.4% YTD).
- IG fund flows were unchanged WoW at $3.8 billion in inflows, the fourth consecutive week of inflows, pushing YTD total to $18.2 billion. New issue supply accelerated to $23.9 billion, with YTD total reaching $130 billion.
- HY fund flows flipped to $1.4 billion in outflows, the largest weekly outflow in four weeks. Supply decelerated to $4.1 billion, taking YTD issuance to $14.9 billion.
- HY dealer inventory increased $0.5 billion to $1.9 billion, the largest HY net long since January 2022.
Our take: Credit markets have ripped in January as cash flowed into both IG and HY funds, bolstering the clean-slate risk on mentality. The soft-landing theme furthered the risk-on sentiment as well. Markets are due for a breather and a pullback; dealer inventories are higher, new issue supply is picking up, and earnings will continue to be challenged as the economy slows. We are still optimistic about forward total returns in both IG and HY, but expect a trading pullback and some volatility, which we fully intend to take advantage of. We also continue to advocate for the up-in-quality theme as the recession starts to bite.
Economic Commentary
- Temporary jobs are a leading indicator of a broader jobs decline, presaging the last three recessions. The 3.5% decrease in temp jobs since July indicates a rapid slowing of the economy.
- The Atlanta Fed’s Q1 GDP Now first take is 0.675%, a marked slowing from 2.9% in Q4.
- Durable goods spending rose 1.8% in October but fell 3.0% in November and 1.9% in December. In real terms, consumption was weak across the board in December. Durable goods -1.6%, nondurable goods -0.5% and services unchanged (0.0%).
- The employment cost index rose 1.0% December from September, or 4.1% at an annual rate, a tenth less than expected, and the smallest increase since a 0.8% increase last June.
- The Federal Reserve raised interest rates another 25 basis points at today’s meeting and indicated a few more 25 basis point hikes are likely needed.
Our take: More data points suggest that the economy is slowing, and price pressures are easing. However, the labor market is still tight based on concurrent indicators. Financial conditions have eased dramatically, making the Fed’s task even more difficult. Given how far rates have come down, the near-term risks are relatively balanced. We don’t believe the Fed would start cutting rates until inflation is conquered OR things have gotten disastrously bad for the economy and risk markets.
Municipal Bond Market Commentary
- Last week high-grade tax-exempt bonds outperformed Treasuries by 2, 7 and 5 bps in the 2-, 5-, and 10-year maturities and underperformed by 4 bps in the 30-year spot. Municipals remain rich versus Treasuries across the curve as AAA Muni/Treasury ratios ended the week at 52%, 57%, 62% and 88%. AA Muni/Corporate ratios also remain rich at 51%, 55% and 55% in 2, 5, and 10 years, but represent better indicate better relative value in the 30 years at 80%.
- For the period ending January 25th, weekly reporting funds indicated $1.3 billion of inflows, consisting of $2 billion of open-end mutual fund inflows and $973 million of outflows from ETFs.
- Primary market issuance this week is extremely light at only $828 million as issuers again elect to remain on the sidelines during a Fed meeting week. Longer-term, strong February reinvestment and moderate projected issuance indicates favorable technical conditions with a net supply of negative $16.3 billion estimated over the next 30 days.
- Secondary market bid-wanted activity as a manageable $5.4 billion last week.
Our take: Activity by individual tax-exempt municipal market investors for the first month of 2023 indicates that they have recognized and are embracing the reality and opportunity presented by the current market environment. In January open-end mutual funds saw $5.5 billion of inflows while municipal ETFs saw outflows of $5.5 billion. Also of note are the $1.96 billion of inflows into high yield open-end funds. This tells us that retail investors understand the importance of a more active investment strategy in the current economic environment — from both a risk management and opportunistic perspective. In addition, we observe that individual investors have begun to reach further out the curve beyond the typical 10-year maturity. This is not simply a search for more yield, but a recognition of the total return opportunity presented by the expected greater price performance of longer duration bonds once the Fed ultimately pauses and then eases monetary policy. While there may still be some bumpiness in the near-term, we think this is the right approach and patient tax-exempt investors will be rewarded for putting money to work now.
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