Weekly Fixed Income Commentary (February 22, 2023)
Corporate Bond Market Commentary
- IG spreads widened 3 bps over the week to 126 bps and yields rose by 11 bps to 5.4% with total returns at -0.7%.
- Estimated IG fund inflows totaled $1.19 billion for the week.
- HY spreads widened 14 bps last week increasing yields by 23 bps to 8.6% with total returns at -0.9%. Yields are now at the highest in six weeks.
- HY funds saw $2.82 billion of outflows for the week, particularly from ETFs, bringing a steady stream of BWICs throughout the week.
- The IG primary market saw $54.2 billion priced double the expected calendar going into the week. The HY primary market ground to a standstill based on market concerns over more aggressive Fed tightening.
Our take: The pullback we have been anticipating continued for a third week, solidifying an ugly February, as fund outflows, and bloated dealer inventories on the back of substantial new issuance generated further froth while US Treasury rates continued their climb. BB and B yields are now at more compelling levels of absolute value not seen since the start of the year, and supply has siphoned off. As many high yield borrowers continue to report, we would expect some stability to arrive soon and believe we are approaching a very attractive entry point for BB and B rated corporate bonds.
Economic Commentary
- The Producer Price Index (“PPI”) rose 0.7% in January exceeding the forecast 0.4% estimate. Excluding food and energy, Core PPI increased 0.5%, higher than the 0.3% consensus forecast. PPI is up 6% and Core PPI is up 5.4% from a year earlier.
- The S&P Global Flash Composite Output Index (“PMI”), based on a survey of purchasing managers in the manufacturing and services sectors, increased to 50.2 in February from 46.8 in January. Crossing 50 indicates expansion for the first time since June 2022. The U.S. services PMI increased to 50.5 from 46.8 beating the 47.0 consensus forecast. The U.S. manufacturing PMI also rose to 47.8 from 46.9, slightly above the forecast level of 47.6, but still indicates contraction.
- The National Association of Realtors reported that existing home sales fell 0.7% from December. This represents the 12th straight month of declines and represents a nearly 37% decline from a year earlier.
- According to Freddie Mac, the average weekly rate on a 30-year mortgage jumped to 6.32% last week, its highest level in five weeks.
Our take: We anticipate Wednesday’s release of the Fed minutes will provide support for the market’s continued reluctant embrace of a more hawkish narrative on the coattails of the recent PPI and CPI numbers indicating more stubborn price inflation. It appears that more pain will be necessary to move towards the Fed’s 2% inflation target and while a pivot to easing will come eventually, it will take more time to get there.
Municipal Bond Market Commentary
- Last week high-grade tax-exempt bonds underperformed Treasuries by 33, 24, 17 and 16 bps in the 2-, 5-, 10- and 30-year maturities. AAA tax-exempt yields increased by 41 bps, 34bps, 25 bps and 21 bps over the week. From a relative value perspective, municipals cheapened compared to both Treasuries and Corporates across the curve. AAA Muni/Treasury ratios ended the week at 60%, 63%, 67% and 93% while AA Muni/Corporate ratios finished at 63%, 59%, 60% and 82%.
- For the period ending Wednesday, February 15th, tax-exempt funds reported outflows of $68 million, consisting of $293 million of inflows to open-end funds and $361 million of outflows from ETFs. Outflows continued over the balance of the week as daily reports for Thursday and Friday indicated aggregate outflows of $651 million.
- Last week’s primary calendar struggled in the face of rising municipal yields. The $1.7 billion University of California tax-exempt issue saw $830 million in interest during a one-day retail order period but following Tuesday’s CPI number underwriters increased yields 7-9 bps to start the institutional order period. Ultimately, an additional 15-20 bps yield increase was required to complete the sale.
- Municipal Bid Wanted volume reported by Bloomberg totaled $6.0 billion for the week.
- The new issue calendar for this holiday-shortened week is just $3.7 billion. Looking out further long-term, 30-day visible supply is only $4.7 billion and with $15.3 of projected reinvestment, net supply is at negative $10.6 billion.
Our take: Tax-exempt yields have risen quickly following last week’s CPI print as concerns over potential 50 bp Fed hikes and a higher terminal rate impacted rates markets overall. Although fund flows have weakened a bit, buyers have cash and cash equivalent yields are attractive. Last week’s new issue struggles evidence a “wait to buy until it’s cheaper” mentality. Tax-exempts are beginning to look more attractive at the long-end on a relative value basis and we are seeing some signs of the beginnings of crossover buyer interest. We are closely watching supply/demand dynamics and economic indicators as we approach a more historically weak technical season – an entry point may be near.
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