Weekly Fixed Income Commentary (February 9, 2023)

Corporate Bond Market Commentary

  • IG credit spreads narrowed 4 bps last week to 115 bps, while yields were 3 bps lower to 4.9%, resulting in a total return of 0.3%.
  • HY credit spreads narrowed 27 bps this past week to 385 bps and yields declined 23 bps WoW to 7.9%, now 83 bps tighter and 108 bps lower YTD, respectively. This generated a total return of 1.0%, the largest gain in three weeks, and extended YTD gains to 5.0%.
  • Across ratings, CCCs outperformed yet again with a total return gain of 1.9% (+8.0% YTD), while single-Bs (+1.0% WoW, +5.1% YTD) and BBs (+0.8% WoW, +4.2% YTD) continued to lag but still generated healthy total return gains.
  • IG fund flows accelerated to $4.8 billion in inflows, as strong mutual fund demand (+$5.1 billion) offset ETF redemptions (-$0.3 billion)- a reversal of the trend seen for most of last year. Supply decelerated to $17.3 billion, with YTD issuance reaching $149.5 billion
  • HY fund flows decelerated to $0.1 billion in outflows, as ETF outflows (-$0.5 billion) outpaced mutual fund inflows (+$0.4 billion). Supply accelerated to $5.5 billion, taking YTD total to $20.4 billion, down 15% ytd vs 2022.
  • Primary dealer inventories in IG dropped $1.3 billion WoW to $4.2 billion as dealers trimmed positions throughout the curve except the very front end. In HY, dealer inventory decreased $0.7 billion to $1.3 billion, as dealers reduced positions across the curve, led by the intermediate and long-end.
  • More recently, the HY market slid 0.6% on Monday, the biggest one-day loss in almost six weeks and the second straight session of declines, with yields jumping the most in three months to 8.05%. The losses spanned across ratings as BBs and single Bs also saw negative returns for the second day in a row after 5-year and 10-year US Treasury yields climbed to close to a four-week high of 3.83% and 3.64%, respectively.

Our take: As we expected in last week’s discussion, the market has pulled back over the last few trading days as rates pushed higher. Spreads are still relatively tight, especially if a recession is on the horizon. Given the backup in rates, the yields on offer in high quality bonds are attractive and we are more focused in this area while also continuing to look for compelling buys in single B-rated companies. In addition, with primary markets open here we are seeing an increasing number of opportunistic refinancings. We think this is an important theme here in both primary and secondary markets and therefore believe looking for refinancing catalyst-driven trades makes sense in our markets rather than just relying on a further generic beta rally from here. It continues to be a great time to be a tactical manager to take advantage of volatility and rapidly changing markets.

Economic Commentary

  • Last week’s jobs report stunned with a 517k rise. The half-million plus rise in payrolls very likely overstates the strength. Seasonal adjustment is tricky in a tight job market, and one of the biggest seasonal swings is in the transition from December to January, when companies start cutting Christmas seasonal workers. For perspective, the not-seasonally-adjusted change in January nonfarm payrolls was -2.5 million, but last year it was -2.8 million. So, there was a +300k swing from 2022 to 2023.
  • Most of the rest of the employment report also speaks to strength. The average workweek rose 0.3%. Aggregate hours worked jumped 1.0%. If there was any weakness, it was the 0.3% rise in average hourly earnings, which subsided from 5.9% year-on-year last spring to 4.4% in January.
  • The slowdown in annual AHE growth could come from two sources. Wage growth could really be slowing, or rapid job growth in lower paying categories could be pulling the average lower. The Atlanta Fed wage tracker, adjusted to reflect year-on-year changes with constant job-quality weights, is also falling, but most recently from 6.5% to 6.3% in December. That’s high enough to suggest a mixture of the two.
  • The huge payroll increase in the establishment survey was compounded by a new low in the unemployment rate, which fell from 3.5% to 3.4%, a new 54-year low.

Our take: The economic calendar is light this week, but picks up again next week with CPI, Hourly Average Earnings, and NFIB Small Business Optimism. The last one in particular is important, as a significant amount of the labor market strength is in small and medium sized businesses, and this is where we will need to see weakness in order for wages to moderate and bring services inflation along with it. We expect rates to drift over the coming weeks and take their cues from the economic data, as Powell clearly told us that both the market and the Fed are completely at the mercy of the data to determine the path of rates.

Municipal Bond Market Commentary

  • Last week high-grade tax-exempt bonds outperformed Treasuries by 8, 6, 2, and 2 bps in the 2-, 5-, 10- and 30-year maturities. Municipals continue to be rich relative to Treasuries across the curve as AAA Muni/Treasury ratios ended the week at 51%, 56%, 80% and 87%. AA Muni/Corporate ratios finished the week at 50%, 53%, 73% and 80%.
  • For the period ending February 1st, weekly reporting funds indicated $362 million of outflows, consisting of $352 million of open-end mutual fund inflows and $714 million of outflows from ETFs.
  • Primary market issuance continued to be light with only $4.3 billion on the calendar. Year-to-date long-term issuance is approximately $25 billion, down $10 billion or 30% compared to the same period last year.
  • Secondary Market Trade Volume reported by the MSRB for last week totaled $46.6 billion down from $57.6 billion for the prior week.
  • The most recent Federal Reserve report on 1/27/23 showed Municipal Dealer inventories of securities with maturities greater than 13 months at $8.7 billion, down from $9.9 billion at year-end 2022.

Our take: Last week is a good illustration of the bumps one must endure on the road to the land of total returns. High-grade tax-exempts rallied 5, 5 and 6 bps in the 5-, 10-, and 30-year spots on Thursday following the Fed’s expected 25 bps increase and unexpected dovish press conference comments on Wednesday, but gave it all back on Friday in reaction to the strong employment report for January, with yields increasing 5, 4 and 4 basis points. While tax-exempts outperformed last week, they have sold off further to start this week, effectively trying to catch up to the move in Treasuries. Technical factors remain constructive overall – fund flows into open-end funds remain positive supported by $24 billion of reinvestment on February 1st with more to follow, and only $5.2 billion of 30-day visible new issue supply. We anticipate a bit of continued drifting to higher yields in the very near term. Mutual funds seem to be awaiting cheaper entry points and, in the absence of a larger primary calendar to aid price discovery, are taking a somewhat patient approach in putting money to work. We suspect this may continue through this week as the market awaits the next CPI report on February 14th.

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