Weekly Fixed Income Commentary (March 23, 2023)
Corporate Bond Market Commentary
- The high yield market widened 56 bps last week to an OAS of 517 bps. The index now sits 36 bps wide to YE22.
- On a total return basis, US HY declined 0.4% on underperformance from CCCs (-2.1%) versus Bs (-0.6%) and BBs (+0.1%).
- IG spreads were 22bps wider last week and are back toward +160bps.
- IG had its first outflow YTD of $3.8 billion, while US HY and Leveraged loans reported accelerated outflows of $1.9 billion and $1.4 billion, respectively.
- There were zero new HY deals last week, and it has now been twelve business days without a deal priced in the US high yield new issue market, the longest deal drought since Covid shut down the market in 2020 for 17 days.
- HY dealer inventories decreased $0.6 billion WoW to $2.3 billion and are rounding into better shape.
Our take: Volatility induced by stress in the banking system drove a flight to quality – lower rates and wider spreads. As calm began to return to the markets, spreads stabilized and started grinding tighter again in higher quality credit. This is why we continue to favor up-in-quality positioning. Lack of new issue supply and moderating dealer inventories are normal course corrections that help to stabilize the market and are functioning properly, and the yields on offer of ~5.5% for BBB and ~7.3% for BB rated bonds remain compelling.
Economic Commentary
- The FOMC raised rates 25bps in an attempt to balance continuing the fight against inflation with modulating stress on the banking system.
- Language in the statement that “The Committee anticipates that ongoing increases in the target range will be appropriate” was replaced with “The Committee anticipates that some additional policy firming may be appropriate,” suggesting rates are at or near a peak before a pause.
- The regional Fed indices continue to report activity levels below the recent trend.
- University of Michigan sentiment, current conditions, and expectations readings were also weak – below consensus and lower than prior month levels.
Our take: The recent stress in the banking system, particularly among regional banks, will have a real impact on the economy going forward. These banks will have to raise deposit rates and pay more for other forms of funding, will have shrinking balance sheets, and will have to preserve capital in advance of likely stricter regulation. All of these changes will render them less willing and able to make loans and other credit available to small and midsized businesses, which have been the engine of job creation and economic growth recently. These tighter financial conditions are similar to the effect that rate increases have, and therefore the path of actual rate increases will likely be lower. Hearing Jerome Powell acknowledge this was comforting, but the landing of the economy will still be harder and sooner than previously expected.
Municipal Bond Market Commentary
- Last week high-grade tax-exempt bonds underperformed Treasuries across the curve by 45, 25, 18 and 5 bps in the 2-, 5-, 10- and 30-year maturities, respectively. AAA Muni/Treasury ratios ended the week at 66%, 68%, 84% and 95% while AA Muni/Corporate ratios finished at 59%, 61%, 61% and 84%.
- For the period ending March 15th, tax-exempt funds reported outflows of $461 million, consisting of $383 million of outflows from open-end funds and $83 million of outflows from ETFs.
- Municipal Bid Wanted volume totaled $5.14 billion for the week.
- Amidst the backdrop of stress in the banking sector, the primary municipal bond market successfully cleared over $6 billion of new issuance last week. This week’s calendar is relatively light (as is now typical during an FOMC meeting week) at $4.1 billion, including $1.5 billion of taxable Louisiana Utilities Restoration Corporation bonds.
Our take: Despite muted new issue activity in other fixed income markets, we found it reassuring to see the both the primary and secondary municipal markets open for business last week as new issues cleared at reasonable levels. Secondary trading continued but declined as MSRB reported secondary trade volume of only $5.7 billion for the week versus $14.5 billion for the prior week. Finding liquidity became more of a challenge particularly at the longer end of the curve. JPM reported that only 30% of bid wanted for bonds 15 years and longer actually traded. Despite the Treasury rally and inflows into high yield tax-exempt funds, we have seen high yield municipals selling off more in sympathy with corporate credit concerns. The underperformance of high-grade tax-exempts relative to Treasuries is understandable given their continued richness. The street has been very focused on quelling any investor fears about potential large-scale bank selling of municipal bond positions – and so far, seems to have succeeded. Anecdotal information indicates that individual retail and managed accounts remain net buyers but at somewhat reduced levels. Dealer risk appetite is limited and that is okay as long as the new issue calendar remains light. We anticipate upcoming opportunities to add additional positions at attractive levels as uncertainty will continue to challenge the market even beyond this week’s Fed decision.
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