Weekly Fixed Income Commentary (February 16, 2023)
Corporate Bond Market Commentary
- IG credit spreads widened 3 bps off the YTD tights this past week to 118 bps, while yields backed up 26 bps WoW to 5.2%. This resulted in excess returns of -33 bps and total returns of -1.8%, the first weekly loss YTD and giving back nearly half the YTD losses generated through the prior week (YTD now +2.2%).
- IG fund flows decelerated to $4.1 billion in inflows, the sixth consecutive week of inflows, which makes it the longest stretch of inflows since October 2021. Supply jumped to $40.9 billion, the highest volume since the first week of January.
- HY credit spreads widened 29 bps this past week to 414 bps, while yields jumped 50 bps WoW to 8.4%. This resulted in excess returns of -96 bps and total returns of -1.8%, the largest weekly total return loss since mid-September. Across ratings, CCCs outperformed single-Bs and BBs, with total return losses of -1.3%, -1.7% and -2.0%, respectively.
- HY fund flows flipped to a marginal inflow, as mutual fund inflows outpaced ETF outflows. However, week-to-date in the current week is a more substantial outflow of ~$2.7 billion. Supply accelerated to $7.1 billion, the highest weekly total since November 2021.
- In HY, dealer inventory increased $0.9 billion to $2.2 billion, the largest net long since November 2021, as dealers added positions throughout the curve.
Our take: The pullback we have been anticipating continued last week and into this week, as fund outflows, higher new issue supply, and somewhat bloated dealer inventories (particularly after they bought a few portfolio trades last week) all combined to produce less supportive market technicals just as US Treasury rates were climbing. BB and B yields are now re-approaching more compelling levels of absolute value, and supply is moderating. We would expect things to begin to stabilize over the coming days and believe we are approaching a very attractive entry point for BB and B rated corporate bonds.
Economic Commentary
- The Federal Reserve Senior Loan Officer Opinion Survey (SLOOS) revealed a further tightening in bank lending conditions, often a harbinger of significant slowing in the economy.
- January’s NFIB optimism index showed a falling percentage expecting to increase compensation despite a slightly better earnings outlook. Inventory expansion plans have been down significantly from December.
- The January CPI report was in-line with expectations, but underlying components reveal some backsliding on certain categories. While we await the lagged impact of higher mortgage rates on housing and OER, progress may be slow over the next few months.
- January retail sales gained 3.0% and were well-ahead of the 2.0% expectation, rebounding from a soft end to 2022. Inflation-adjusted retail sales have recovered to the pre-pandemic trend line for the first time since April 2022.
Our take: Recent corporate management commentaries on earnings calls are more upbeat and consistent with the pickup in economic activity. Whether this proves to be a bounce ahead of a rapid descent, or a reacceleration in activity will be crucial in the forward path of interest rates. The Fed was already facing a challenging labor market and services sector even before the concept of ‘no landing’ entered the conversation. If consumer spending in the goods sector were to regain momentum, much of the hard work on inflation will have been undone by the significant easing of financial conditions over the last few months. This would force the Fed to get more aggressive on raising rates while also further increasing the odds of over-tightening and causing a more severe recession down the road.
Municipal Bond Market Commentary
- Last week high-grade tax-exempt bonds outperformed Treasuries by 5, 18, 16 and 9 bps in the 2-, 5-, 10- and 30-year maturities. Municipals remain rich across the curve relative to Treasuries with AAA Muni/Treasury ratios ending the week at 52%, 54%, 60% and 86%. Tax-exempts are also not very attractive compared to Corporate alternatives in 2, 5 and 10 years with AA Muni/Corporate ratios finishing the week at 52%, 53 % and 55%. Out longer high-grade municipals look better relative to Corporates with the 30-year ratio at 78%.
- For the period ending February 8th, weekly reporting funds indicated $775 million of inflows, consisting of $1.2 billion of open-end mutual fund inflows and $475 million of outflows from ETFs.
- This week’s primary market calendar totals $8.2 billion with two different California issues making up approximately $2.7 billion of the offerings. Longer-term supply indications remain light with the Bond Buyer 30-day Visible Supply at only $10 billion.
- Municipal Bid Wanted volume reported by Bloomberg totaled $5.8 billion for the week.
Our take: While we are pleased to see the continuation of aggregate positive inflows to tax-exempt funds, the macro-backdrop appears to be an important influence on institutional municipal market participants and their willingness (or reluctance) to put capital to work. While open-end mutual funds seem to have plenty of cash available, a number of the new issues last week saw weaker buyer interest than one would typically expect in a supply-starved market. The weaker interest can certainly be understood in part by rich relative value levels, and institutional buyers may well be waiting for cheaper entry points that might arrive with additional Fed hikes or more new issue supply or a combination of both. Or they simply wanted to get through this week’s CPI report. At the same time direct retail investors continue to be fully engaged as net buyers and are reaching further out the curve in search of more yield. Currently you can gain 12 bps going from 5 to 10 years but can pick up 59 bps by extending further from 10 to 15 years. At the very short end of the curve, Treasuries or taxable municipals may present better opportunities.
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