Weekly Fixed Income Commentary (May 18, 2023)
Corporate Bond Market Commentary
- U.S. High Yield tightened 1 bp last week to an OAS of 476 bp. The index now sits 5 bp tight to YE22.
- On a total return basis, U.S. HY was flat as negative returns for BBs (-0.1%) and CCCs (-0.1%) were offset by positive returns for Bs (+0.1%). On a YTD basis, U.S. HY is +4.3% with CCCs (+7%) still leading Bs (+4.5%) and BBs (+3.6%).
- HY funds reported a net outflow of $1.2 billion last week.
- HY primary markets were active again last week with ~$4 billion of total volume.
- Investment Grade spreads were unchanged last week, with rising treasury yields driving a -0.2% total return loss. Supply was $33.4 billion last week, and very heavy this week including the $31 billion Pfizer deal, the fourth largest US IG bond sale in history.
Our take: Spreads have been relatively rangebound as investors weigh the uncertainties of the economy, the Fed, the debt ceiling, etc. While we may get some clarity on the debt ceiling soon, the economy will be in an evolving situation for a while. We still believe the economy is slowing, and will continue to do so, and advocate an up in quality positioning (IG, BB, select strong Bs), while staying vigilant for signs we may be wrong, and keeping a few higher risk trades on the shelf ready to be bought in an instant if things change for the better. This agility is one of the benefits of a tactical mandate.
Economic Commentary
- Last week, CPI and PPI were largely in line with expectations, and show a continued gradual improvement of inflation.
- University of Michigan sentiment and current conditions weakened, and notably the 5-to-10-year inflation expectation rose from 3.0% to 3.2%, something to keep an eye on in the months ahead.
- The NY Fed’s Empire manufacturing index plummeted from 10.8 to -31.8, the lowest since January and the biggest month-to-month swing since April 2020, the start of the pandemic lockdowns. Weakness was all in current conditions. New orders plunged, shipments plunged, delivery times quickened, inventories and unfilled orders dropped.
- Retail sales were stronger than consensus, especially control group and excluding auto & gasoline. However, beneath the surface there were numerous pockets of weakness. Retailer earnings kicked off this week, with Home Depot and Target both warning of softening sales trends.
- We are rapidly approaching Treasury Secretary Yellen’s stated June 1 “x-date” when the US government will default if the debt ceiling isn’t raised. There has been little apparent progress, but party leaders from both the House and Senate remained optimistic that a compromise would be reached as they all agree that a default would be potentially catastrophic. While we believe that the likelihood of default remains slim, we are actively monitoring.
Our take: While economic data releases and real-world company earnings and outlooks are showing signs of slowing, the Fed continues to keep its options open on future hikes, while pushing back against market expectations of cuts in 2H 2023. We continue to believe the Fed will err on the side of stomping-out inflation rather than risk entrenchment or recurrence, and will overtighten in the process, necessarily causing a slowdown in the economy.
Municipal Bond Market Commentary
- For the week ending May 12, 2023, looking at the data in the 2-, 5-, 10-, and 30-year maturities, high grade tax-exempt bonds outperformed US Treasuries across the curve by 5, 2, 2, and 2 bps. Ratios were little changed as AAA Muni/Treasury ratios ended the week at 67%, 68%, 67%, 82% and 89%. AA Muni/AA Corporate ratios finished the week at 66%, 63%, 58%, 72%, and 80% respectively.
- For the period ending May 10, tax-exempt funds reported inflows of $199 million, consisting of $52 million of inflows to open-end funds and $148 million of inflows to ETFs.
- The new issue calendar for the week totals $7.4 billion, consisting of tax-exempt supply of $6.9 billion and taxable offerings of $552 million. The tax-exempt and taxable supply are 85% and 42% of the 5-year average respectively.
Our take: Tax-exempt bonds outperformed (slightly) on the week and remain relatively rich as negative net supply is forecast over the next several months when growth in reinvestment dollars outpaces growth in expected supply. The municipal market outperformed US Treasuries even as the sale of the taxable portion of the SVB and Signature Bank municipal portfolios held by the FDIC were completed last week, and BlackRock began selling the tax-exempt portion of the portfolios. The expected strong technical environment and likelihood of a Fed pause in rate hikes should continue to support municipal bond values.
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