Weekly Fixed Income Commentary (May 25, 2023)
Corporate Bond Market Commentary
- U.S. High Yield tightened 14 bp last week to an OAS of 462 bp. On a total return basis, U.S. HY was down 0.4% on broad-based negative performance from BBs (-0.6%), Bs (-0.3%) and CCCs (-0.5%). On a YTD basis, U.S. HY is now +3.8% with CCCs (+6.5%) still leading Bs (+4.2%) and BBs (+3%).
- This was the biggest loss for BBs in 10 weeks, as yields climbed for the third straight week reaching 7.18% and continuing higher so far this week.
- High yield funds reported a net outflow of $1.2 billion last week.
- HY primary markets were active again last week with ~$7 billion of total volume. Year to date issuance totals ~$75 billion, up 30% versus 2022.
- Investment grade bonds returned -1.47% last week on rising UST rates. Heavy new issue supply of ~$58 billion was led by a $31 billion deal from Pfizer, and there were $2.2 billion of inflows into IG funds.
Our take: The slow but steady move higher in rates over the last several weeks has pushed all-in yields on BBBs and BBs back to compelling levels of ~5.75% and ~7.25%. Corporate earnings are generally holding up well, for now, with signs of slowing revenue offset by moderating cost inflation, particularly on freight and other supply chain expenses. This is a good entry point to add some more high-quality fixed income.
Economic Commentary
- From a macro-economic and markets standpoint, it does not much matter how a debt-ceiling deal is reached, as long as it is reached. The details, whether they include spending caps, closed tax loopholes, and/or the kind of work requirements and permit simplification being discussed in these talks will do little if any economic harm, especially compared to the harm of not reaching a compromise.
- The S&P global manufacturing index fell from 50.2 to 48.5, more than expected, but services accelerated from 53.6 to 55.1, also unexpected. On net, the economy is accelerating, as the composite index rose from 53.4 to 54.5.
- Initial and continuing jobless claims moderated after the previous week’s surprisingly soft report, which was clouded by fraudulent claims in Massachusetts.
- Bloomberg News notes the Fed is trying to walk a path that will fight inflation while also stabilizing the bank sector, and these two goals are, to an extent, contradictory. On Friday, Jay Powell acknowledged the credit tightening coming from the bank shakeup, and said he was willing to pause at the June 13-14 meeting to allow time to see more of what bank turmoil might do to credit. But Fed Presidents Lorie Logan, Neel Kashkari, James Bullard, and Loretta Mester worry inflation will not fall fast enough without further tightening. FOMC minutes released on Wednesday illustrate the debate, which is common around inflection points in rate cycles.
Our take: The posturing and politicking on the debt ceiling negotiations are to be expected. This will get resolved, eventually. There will be impacts on interest rates due to normalization of the curve around the X-date, a wave of T-bill issuance, possible fiscal austerity, and other effects, but most importantly it will refocus everyone on the economy, inflation, and the Fed’s efforts to restore price stability. Whether they raise 25bps in June or July, they are intent on finishing the job and will likely overcorrect in the process. In essence, good news will eventually be bad news for the economy. Reduce credit risk and increase duration accordingly.
Municipal Bond Market Commentary
- For the week ending May 19, 2023, looking at the data in the 2, 5, 10-year maturities, high grade tax-exempt bonds underperformed US Treasuries across the curve by 7, 2, and 1 bps, and outperformed in 30 years by 1 bp. Ratios are slightly higher through the 10-year maturity and unchanged for the 30-year, with AAA Muni/Treasury ratios ending the week at 71%, 71%, 69% and 89%. The AA Muni/AA Corporate ratio finished the week at 67%, 65%, 61%, and 81% respectively.
- For the period ending May 17, tax-exempt funds reported outflows of $187 million, consisting of $72 million of outflows in open-end funds and $115 million of outflows in ETFs.
- The new issue calendar for the week totals $6.4 billion, consisting of tax-exempt supply of $6.3 billion and taxable offerings of $111 million. The tax-exempt and taxable supply are 98% and 7% of the 5-year average respectively. Year-to-date issuance is lagging 2022 by 13% for tax-exempt municipal bonds and 53% for taxable municipal bonds.
Our take: It was a tough week for the municipal market with rising yields in the US Treasury market, fund outflows, and no apparent progress on the debt ceiling. Though the impact is probably minimal, continued selling of the Silicon Valley Bank portfolio added to the pressure on the municipal market. JP Morgan estimates 12% of the tax-exempts in the Silicon Valley Bank portfolio have been sold as of May 19th. We believe the municipal bond market is relatively rich on a historical basis and will remain that way for at least the next several months. Strong market technicals driven by re-investment dollars exceeding new issuance should keep the market from cheapening, while upside is limited because the market is already rich. As long as this persists, we expect taxable bonds, both corporate and municipal, to be more fertile markets for new investment opportunities.
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