Weekly Fixed Income Commentary (August 10, 2023)
Economic Commentary
- Economic data was light economic data this week ahead of today’s CPI and Friday’s PPI reports
- CPI came in broadly in line with expectations, rising 0.2% MoM and 3.2% YoY. Core CPI rose 0.2% MoM and 4.7% YoY. Sometimes meeting expectations feels like a win, and this report falls into that category.
- Nonfarm productivity beat expectations, rising 3.7% in the second quarter after falling 1.2% in the first, an encouraging sign as the cost of labor and investment increases. Furthermore, real average hourly earnings decelerated to 1.1% and real average weekly earnings were up only 0.2% YoY.
- Fitch downgraded US Treasury debt last week from AAA to AA+, citing poor fiscal discipline after years of tax cuts, spending growth, rising debt costs, and political gridlock.
- The NFIB survey, which focuses on small businesses, showed the lowest reading for the “Actual Price Changes” component since February 2021.
- One of the reasons we expect the Fed to tighten this at least once, if not two more times this year, is because the FOMC will want to avoid having to think about hiking next year. Policy is restrictive. In the past, the Fed has rushed to make policy changes before the start of an election year not just because they don’t want to make waves if they can avoid it but to avoid accusations of affecting the political outcome.
Our take: Long-end treasury yields have stabilized and begun grinding lower after the JGB / Fitch / increased auction supply triple whammy last week. Very light August trading volumes magnify these moves. While those factors are important to consider, US economic fundamentals should rise to the forefront again with CPI/PPI releases this week. Looking further ahead, Jerome Powell’s speech at the Jackson Hole Economic Policy Symposium August 24-26th should offer direction on the near-term path of rates as well.
Corporate Bond Market Commentary
- U.S. High Yield widened 19 bp last week to an OAS of 401 bp. The index now sits 80 bp tight to YE22.
- On a total return basis, US HY was down -0.4% reflecting broad-based negative performance from CCCs (-0.5%), Bs (-0.4%) and BBs (-0.4%). On a YTD basis, HY is up 6.3% with CCCs (+11.7%) leading Bs (+6.7%) and BBs (+4.8%).
- HY funds reported a net outflow of $1 billion last week. Primary markets remained relatively active last week with ~$3 billion of total volume.
- US IG spreads widened 3bp to +122bp while yields climbed 7bp, leaving total returns at -0.7%. New issue supply was $35 billion and fund flows were a -$1.765 billion outflow.
Our take: The big rate moves last week drove negative performance and fund outflows, but spreads were relatively resilient. Credit markets have so far shrugged off mediocre earnings, only really punishing significant negative surprises. We expect dispersion to increase, and the prevalence of downside idiosyncratic performance is increasing. This is not the point in the credit cycle to reach for additional spread, especially when yields on higher quality credit are better than they have been in years. A combination of high-quality IG and BB duration, paired with front-end high yield is an attractive barbell strategy.
Municipal Bond Market Commentary
- For the week ending August 4, 2023, high grade tax-exempt municipal bonds yields were 21, 22, 23 and 23 bps higher across the curve at 2,5,10, and 30 years, underperforming US Treasuries by 32, 27, 14, and 4 bps in 2, 5, 10, and 30 years respectively.
- Ratios were higher across the curve, with AAA Muni/Treasury ratios ending the week at 66%, 68%, 68% and 90% at 2,5, 10, and 30 years. AA Muni/AA Corporate ratios also moved higher, finishing the week at 67%, 65% and 63%, and 79% in the 2-, 5-, 10- and 30-year maturities.
- For the period ending August 2, tax-exempt funds reported outflows of $455 million, with $132 million of outflows from ETFs and $323 million out of open-end funds.
- The new issue muni calendar is estimated to be $7.7 billion, comprised of $6.8 billion in tax-exempt and $900 million of taxable issuance.
Our take: The muni market underperformed last week as it absorbed a larger than normal new issuance calendar and US Treasuries steepened substantially. The Summer technical supply imbalance remains in place but is waning, with current visible net supply is -$7.2 billion and ratios moving higher across the curve. Given the combination of higher yields and improved relative value of high-grade municipal bonds, this week should be an opportune time to put excess cash to work in tax exempt municipal accounts.
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