Weekly Fixed Income Commentary (August 24, 2023)
Economic Commentary
- US Manufacturing PMI came in at 47.0, below last month’s 49.0 and consensus expectation of 49.0. Services PMI also came in weaker at 51.0 versus 52.3 last month and 52.2 expectation. PMIs in Germany, the UK, and the overall Eurozone also came in weak, showing signs of global economic cooling.
- The Mortgage Bankers’ Association reported average 30-yr fixed mortgage rates rose to 7.31% last week, the highest since late 2000. The rise in rates is discouraging home turnover, as existing owners are reluctant to lose mortgages financed, or refinanced, near 3%. Existing home sales fell 2.2% in July.
- The CEO of a large department store (Macy’s) reported in its earnings call yesterday that, although the store expected “delinquencies to rise in a normalizing credit environment,” its credit card delinquencies had risen “faster than expected” last quarter. This mirrors recent earnings reports from other retailers that are becoming more pessimistic on consumer strength. While business pessimism should be taken with a grain of salt given deteriorating sentiment the last couple years has coexisted with solid consumer spending, robust hiring, and solid investment, delinquencies are concrete signs of consumer distress. There has been a rapid uptick in delinquencies since the Fed started raising rates last year, already rising to the highest rate since 2012.
Our take: We believe the Macy’s warning on credit card delinquencies is a canary in the coal mine. This is not a low-end consumer; it is a solid middle class / upper middle class customer base. As retailer earnings season continues, Macy’s is not the only management team warning of slowing consumer demand. Just wait until higher interest rates continue to work through the economy with their typical lag, things should only continue to get worse. While central bankers take victory laps about reducing inflation with a no-landing scenario, their enthusiasm is premature. Prepare your portfolios accordingly.
Corporate Bond Market Commentary
- U.S. High Yield widened 19 bp last week to an OAS of 402 bp. The index now sits 79 bp tight to YE22. On a total return basis, US HY was down -0.8% reflecting broad-based negative performance from BBs (-0.9%), Bs (-0.8%) and CCCs (-0.5%). BB yields reached a five-month high of 7.39%.
- HY funds reported a net outflow of $1.1 billion last week, the fourth consecutive week of outflows.
- US HY primary markets were somewhat active last week with almost $3 billion of total volume. Tenneco underwriters priced the previously hung $1.9 billion of 8Y senior secured notes at a new issue yield of almost 12%; the bonds promptly traded down 3 points, an ominous sign for the wave of supply that is expected to come after Labor Day.
- U.S. IG spreads widened 5bp last week to +127bp, while yields rose 11bp to 5.84%, marking the highest IG YTW since mid-November 2022. Rising UST yields drove total return losses of -0.7%. The IG primary market was relatively quiet, with only $13.4 billion pricing, below expectations of $20 billion.
Our take: The recent sharp move higher in yields, particularly at the longer end of the curve, has moved all-in yields back to very compelling levels for higher quality bonds. As we have mentioned previously, these higher quality investments are on sale just when they are most attractive – when the economy starts to slow. We advocate trimming lower-quality credit exposure and private credit exposure and rotating into IG and BB intermediate and longer dated bonds. Once it is readily apparent the economy is slowing markedly, you will have already missed the golden opportunity.
Municipal Bond Market Commentary
- For the week ending August 18, 2023, high grade tax-exempt municipal bond yields were 7, 9, 12 and 12 bps higher across the curve at 2,5,10, and 30 years, underperforming US Treasuries by 2 bps in 2 and 10 years, matching the US Treasuries in 5 and 30 years respectively.
- AAA Muni/Treasury ratios were slightly higher, up 1% ending at 64%, 65%, and 66% at 2,5, and 10 years, with the 30-year ratio unchanged at 88%. AA Muni/AA Corporate ratios were unchanged at 63%, 62%, and 62% at 2, 5, and 10 years and up 1% to 78% at 30 years.
- For the period ending August 16, municipal bond funds reported outflows of $264 million, of which $63 million was out of muni ETFs and $201 million was out of open-end funds.
- The new issue muni calendar this week is estimated to be $8.1 billion.
Our take: The municipal market is reflecting the recent rising rates in the benchmark US Treasury curve. The Summer seasonal technical supply imbalance is disappearing, with current visible net supply at -$5.1 billion. The supply imbalance is expected to disappear or even reverse over the next several months, which will likely move AAA Muni/Treasury ratios higher, but overall direction of the market will still be dictated primarily by changes in the US Treasury curve.
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