Weekly Fixed Income Commentary (July 20, 2023)
Economic Commentary
- US retail sales rose +0.2% at the headline level versus the +0.5% consensus, sales excluding autos & gas were in-line with consensus at +0.3%, and the control group sales increase of +0.6% was above expectations of +0.3%. The prior month’s figures were also revised higher.
- CPI in the UK fell from 8.7% to a 15-month low of 7.9% in June. The Bank of England is now expected to only hike 25bp rather than 50bp at their next meeting, and the terminal rate is expected to peak at 5.75% rather than 6%. This had a positive effect on US rates as well.
- The Atlanta Fed Q2 GDPNow forecast is currently 2.4%.
- The early days of corporate earnings season have shown mixed results for financial institutions relative to expectations. Nothing suggests the banking industry is in the clear, but performance during the first full quarter following bank failures earlier this year also doesn’t look like the imminent disaster some feared as recently as April.
Our take: Fed governors are in the quiet period ahead of next week’s meeting, where a 25bp hike is set in stone. There will be plenty of data released before the next meeting in September, and plenty of opportunities for additional communication and guidance as to whether a skip or a hike may be prudent. The soft-landing scenario has been gaining traction recently; we’re not as confident, as resilient consumers and tight labor markets may embolden the Fed to keep tightening, which would raise the risk of an overcorrection and harder landing.
Corporate Bond Market Commentary
- U.S. High Yield tightened 18 bp last week to an OAS of 390 bp. The index now sits 91 bp tight to YE22.
- On a total return basis, US HY increased +1.7% on broad-based positive performance from CCCs (+2.1%), Bs (+1.6%) and BBs (+1.7%). On a YTD basis, US HY is up +6.6% with CCCs (+11.7%) leading Bs (+6.9%) and BBs (+5.3%).
- HY funds reported a net outflow of $379 million last week. US HY primary markets were quiet for a second consecutive week with only $500 million of issuance.
- Investment grade bond spreads were unchanged at +128bp, while yields fell by 25bp to 5.50%, resulting in total return gains of +1.62%.
- Fund flows were a modest +$691 million. IG primary priced $10.95 billion last week, lower than projections of $15 billion. Volume should pick up this week on the back of bank earnings and ahead of next week’s FOMC meeting.
Our take: Credit markets have been strong since the softer CPI / PPI readings last week, largely attributable to more benign landing scenarios and a decrease in UST rates. While we are in complete agreement that rates should be trending lower, we aren’t as sanguine about the prospects for a smooth and easy landing. If the Fed thinks the economy can withstand additional tightening, it will weigh overcorrection as less of a risk and behave accordingly. We continue to favor more duration risk and less credit risk for positioning. We will be carefully dissecting corporate earnings reports over the coming days and weeks for signs of consumer demand, price elasticity, margins, and employment.
Municipal Bond Market Commentary
- For the week ending July 14, 2023, high grade tax-exempt municipal bond yields were 7, 7, 6, and 6 bps lower across the curve at 2,5,10, and 30 years, underperforming US Treasuries by 11, 24, 16 and 6 bps respectively.
- Ratios rose as a result of the relative underperformance, with AAA Muni/Treasury ratios ending the week at 61%, 64%, 67% and 91% at 2, 5, 10 and 30 years. The AA Muni/AA Corporate ratio finished the week unchanged in 2 and 30 years at 60% and 78%, and 2% higher in the 5 and 10 years with both at 61%.
- For the period ending July 12, tax-exempt funds reported outflows of $484 million, with ETFs showing outflows of $132 million and open-end fund outflows of $352 million.
- The new issue muni calendar is $9.4 billion for the week, $7.8 billion of which is tax-exempt and $1.6 billion is taxable.
Our take: With the economic data last week showing signs of moderating inflation and the subsequent rally in the US Treasury market, we would expect muni bond performance to “catch up” to the US Treasury rally if the market holds the lower yields. The technical supply imbalance remains, and we make no changes to our near-term outlook for continued richness in the muni market over the summer months, as new issuance is expected to be well short of reinvestment dollars from called and matured bonds. Current visible net supply is -$16.0 billion.
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