Weekly Fixed Income Commentary (March 30, 2023)
Corporate Bond Market Commentary
- US High Yield widened 5 bps last week to an OAS of 522 bps. The index now sits 41 bps wide to YE22. On a total return basis, US HY increased 0.3% on outperformance from BBs (+0.5%) versus Bs (+0.3%) and CCCs (-0.3%), with CCCs posting losses for the third week in a row.
- Investment grade bond spreads tightened 9 bps to +148 and total returns were +0.86%.
- High-yield funds had net outflows of $902 million, down from $1.43 billion the week prior and marks the fifth weekly outflow over the past six weeks for net outflows of $13.57 billion over the span.
- Another zero-deal week in the US high yield new issue market, making it the third zero-deal week in a row. MTD issuance totals only $4 billion.
Our take: A resilient performance last week amidst the continued turmoil in the financial system, an FOMC meeting, and varied economic data. Lack of new issue supply is helping to modulate the supply / demand balance, and fund flows, while negative, aren’t unreasonable. We think the market can trade relatively sideways for a few weeks within a range, at least until Q1 corporate earnings start to roll in and give us more visibility on individual company performance during these turbulent times. We remain positioned up in quality for the recession we expect to hit over the coming months.
Economic Commentary
- This week, there’s not much on the economic calendar until Friday’s income, consumption, and PCE report. The headline PCE deflator is expected to drop from 5.4% to 5.1%, but the core is expected to be unchanged at 4.7%.
- Durable goods orders were weaker than expected in February. Headline orders fell 1.0%. They were expected to increase by 0.2%. January headline orders were revised from -4.5% to -5.0%. Considerable weakness in capital goods is consistent with other measures of manufacturing weakness, including falling industrial production and recent weakness in the ISM manufacturing index. Manufacturing is more interest rate sensitive than services, and always weakens before the rest of the economy. If there is anything remarkable about it, it is the fact orders are weak despite some fairly hefty stimulus from last year’s CHIPS bill.
- The Richmond Fed Business Conditions and Dallas Fed Services Activity reports for March both came in below February, continuing the trend of weak regional Fed survey data and possibly a more accurate concurrent indicator of a slowing economy.
- Weekly banking industry data showed a significant shift in deposits from smaller banks to larger banks, reinforcing the theme of further tightening of financial conditions in the real world.
Our take: We will be in a holding pattern for 6 weeks until the next FOMC meeting, or possibly longer, watching for signs of real time impacts on the economy from the crisis in the small and midsize banking system. The actual arrival of a more pronounced slowdown in the economy is more a question of when rather than if. The market is bouncing from crisis flash point to flash point – Deutsche Bank, Schwab, commercial real estate and others. Look for Q1 bank earnings to be a key series of events to monitor for signs of further concern or all-clear for the stability of the system.
Municipal Bond Market Commentary
- Last week high-grade tax-exempt bonds outperformed Treasuries across the curve by 7, 6, 7 and 11 bps in the 2-, 5-, 10- and 30-year maturities, respectively. Tax-exempt bonds richened relative to both Treasuries and Corporate bond alternatives. AAA Muni/Treasury ratios ended the week at 64%, 66%, 68% and 92%, while AA Muni/Corporate ratios finished at 59% in 2, 5, and 10 years and at 82% in 30 years.
- For the period ending March 22nd, tax-exempt funds reported outflows of $427 million, consisting of $447 million of outflows from open-end funds and $20 million of inflows to ETFs. Year-to-date outflows total $1.5 billion.
- The primary market calendar for this week totals a modest $5.2 billion. Looking longer-term the Bond Buyer 30-day supply indicates only $9.3 billion of new issues.
- Over the past two weeks, since the Silicon Valley Bank failure, Secondary Market municipal trade volume reported by the Municipal Securities Rulemaking Board has totaled $12.4 billion which is only approximately 50% of the volume reported for the prior two weeks.
Our take: Despite ongoing Treasury market volatility, tax-exempt municipal bonds demonstrated continued resilience as we approach the end of March. Both the Bloomberg Municipal (1.97%) and High Yield Municipal (1.39%) indices are putting up solid return numbers month-to-date (3/27/23). New issue supply continues to be limited as issuers seem content to await completion of the Fed’s rate hiking actions while they finalize state and municipal budgets and related financing plans. Direct retail and SMA demand remains firm and continues to push ratios to richer levels, especially at the front-end of the curve. Meanwhile, institutional investors also seem to be in a waiting mode, as trading activity has slowed. This is certainly explained in part by market participants taking time to fully digest the impact of stress on the banking sector along with a widening of credit spreads and dealer reluctance to take on risk. April and May are not particularly supportive months from a technical perspective as reinvestment flows are limited. We anticipate that the municipal market will likely run in place through the May 6th FOMC meeting and then begin to move in an increasingly positive direction as we head into the Summer.
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