Weekly Fixed Income Commentary (June 15, 2023)
Corporate Bond Market Commentary
- U.S. High Yield tightened 8 bp last week to an OAS of 429 bp. The index now sits 52 bp tight to YE22.
- On a total return basis, US HY rose 0.3% on outsized positive performance from CCCs (+1.5%) versus Bs (+0.4%) and BBs (flat). On a YTD basis, HY is now +5% with CCCs (+8.8%) leading Bs (+5.3%) and BBs (+3.9%).
- HY funds reported a net inflow of $2.5 billion last week.
- HY primary markets were relatively active last week with ~$4 billion of total volume. YTD issuance now totals ~$82 billion.
- U.S. IG spreads were 1bp wider to +140 and total returns were -0.31%.
Our take: The strong rally in risk assets after the resolution of the debt ceiling uncertainty continued unabated last week, as evidenced by the outperformance by lower-rated segments of the market. The relatively light new issue supply is allowing the momentum to continue, and barring pre-announcement warnings, potential earnings disappointments won’t get in the way until mid-July. Riding this wave a bit longer might work out ok, but take advantage of strength in borderline credits to take chips off the table and position for continuing slowdown in the economy. We expect single-name dispersion to increase going forward, as winners are rewarded and losers get punished, which would play to our strengths as credit pickers.
Economic Commentary
- May CPI rose 0.1% headline and 0.4% core, as expected, in May. The year-on-year CPI, at 4.0%, was a tenth lower than expected, while the core, at 5.3%, was a tenth higher.
- The May PPI fell 0.3%, two tenths below the consensus expectation for a 0.1% decline. The PPI excluding food and energy rose 0.2%, in line with consensus. The PPI excluding food, energy, and trade services was unchanged, two tenths below the consensus estimate for a 0.2% increase. The headline PPI rose 1.1% year-on-year, a marked slowdown from 2.3% in April. The momentum in the core has been gradually decelerating and, outside a January blip, has been consistent with the Fed’s longer-term 2% inflation target.
- The Federal Reserve delivered a hawkish skip at today’s meeting and press conference. They chose not to raise rates today, but signaled that July will be a live meeting, and additional rate increases may be appropriate. The dot plots were generally revised to show slower progress on inflation, higher terminal rates, and a longer stay at those higher levels before rate cuts eventually become warranted.
Our take: The FOMC delivered a hawkish skip, as expected. The Fed updated their dot plots, which showed a median terminal rate of 5.6%, implying 50bp of additional rate hikes, whereas markets expect a 25bp hike in July, and none thereafter. Rate cuts have consistently been pushed back, mostly out of 2023 and into 2024. While the timing of reaching terminal rates or the first rate cuts may be shifting, it does not change our view that the Fed will overcorrect, slow the economy and trigger eventual cuts in rates. Therefore, taking duration risk is more prudent than taking credit risk at this point in the cycle.
Municipal Bond Market Commentary
- For the week ending June 9, 2023, looking at the data in the 2-, 5-, 10- and 30-year maturities, high grade tax-exempt bond yields fell 4, 0, 0 and 0 bps, which outperformed US Treasuries by 14, 7, 5 and 0 bps. AAA Muni/Treasury ratios ended the week at 64%, 68%, 69% and 93% for the 2-, 5-, 10-, and 30-year tenors. AA Muni/AA Corporate ratio finished the week at 63%, 62%, 62%, and 79% respectively, in both cases the ratios were just slightly richer from 2-10 years and unchanged at 30 years.
- For the week ending June 7, open-end municipal bond funds reported outflows of $652 million and ETFs had $120 million in outflows.
- The municipal bond new issue calendar, with a forecast of $3.2 billion of tax-exempt and $371 million of taxable bonds, is fairly light which is typical for the week of FOMC meetings.
- The sale of the FDIC portfolio of tax-exempt municipal bonds (previously held by Silicon Valley Bank and Signature Bank) is almost halfway done, with $3.8 billion of an initial $6.9 billion remaining to be sold.
Our take: Municipal bonds held firm as US Treasuries sold off last week, carrying momentum from the strong jobs report into the next week, leaving an already rich market slightly richer. All eyes this week for all fixed income markets have been on the economic data, especially CPI and PPI leading up to the FOMC rate decision. Our view of the near-term municipal bond market is unchanged that the tax-exempt muni markets will remain rich through the summer months due to strong market technicals, with re-investment dollars exceeding new issuance. Bloomberg currently shows visible net supply at -$31.5 billion. The primary focus of new investments will likely be in taxable fixed income securities until tax-exempt municipals cheapen on a relative basis.
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