Weekly Fixed Income Commentary (September 7, 2023)
Economic Commentary
- The August ISM Services index rose from 52.7 to 54.5, two points above the 52.5 consensus. The survey shows broad strength in the services sector, more than making up for persistent weakness on the goods side of the economy.
- Recently oil prices were hovering around $80 a barrel, but now they are holding over $85 at $87.22 this morning after Saudi Arabia and Russia agreed last week to keep production limits in place longer than originally promised.
- The UAW will strike all of the Big 3 automakers, rather than only targeting one of them, if agreements aren’t reached by September 14th. The economic consequences of any prolonged walkout would be significant. And even if an agreement is reached, US Dealer inventory of light vehicles reached 1.9 million units, the highest level since January, as the OEMs built inventory ahead of possible strikes. These companies essentially overproduced the last several months, which aided economic activity. The reversal could bring a nasty hangover.
- The August employment report showed surprisingly solid job growth, but also an unexpected jump in the unemployment rate from 3.5% to 3.8%. Nonfarm payrolls rose 187k in August. The combined -110k two-month revision was quite a bit bigger than usual.
Our take: After a string of weak economic data, recent data releases have been a bit more mixed. It is very common for the statistics to be volatile and confusing at inflection points in the cycle. Focusing on leading indicators rather than concurrent or lagging ones offers the best read on where we are headed, and we believe this cohort of statistics is clearly signaling economic weakness ahead. Coupled with management commentary on recent earnings calls and at conference presentations, especially retailers with their fingers firmly on the pulse of American consumers, the picture is becoming clearer that caution is warranted and eventually interest rates will head meaningfully lower.
Corporate Bond Market Commentary
- HY spreads tightened 9bp last week to +381bp. On a total return basis HY was +1.0% reflecting broad based performance from BBs (+1.0%), Bs (+1.0%) and CCCs (+1.1%).
- HY funds had $1.2 billion of inflows last week.
- IG spreads tightened 1bp last week to +122bp, while yields fell 8bp to 5.74%. Total returns were +0.46%. Fund outflows were -$971 million.
- Primary markets were quiet last week but the expected corporate supply arrived this week, with more than $50 billion pricing from 30 companies, including $38.2b pricing from 21 issuers across a record 49 tranches on just Tuesday alone. This compares to $35.4 billion across 19 deals last Tuesday post Labor Day and is the largest single day tally for IG primary since 4/30/20 when Boeing brought a $25 billion deal to market. Issuance is expected to remain heavy but should taper as the week winds down.
Our take: September arrived with a bang, as the expected tsunami of issuance was even stronger than expected, at least initially. Spreads are starting to widen, ETFs are beginning to launch BWICs, and the technical picture is showing signs of wobbling. If the HY calendar picks up next week with large LBO driven deals like Worldpay and Viasat, the pressure will start to build, and performance will suffer. This could commence a negative performance -> fund outflow feedback loop. We continue to like our up-in-quality positioning coupled with a cash balance and shopping list as bonds we like go on sale.
Municipal Bond Market Commentary
- For the week ending September 1, 2023, high grade tax-exempt municipal bonds yields were 4, 4, 3 and 3 bps lower across the curve at 2,5,10, and 30 years, outperforming US Treasuries by 4 bps in 30 years, and underperforming the US Treasuries by 16, 10, and 2 bps in 2, 5, and 10 years respectively.
- AAA Muni/Treasury ratios were up 2% in 2 years, up 1% in 5 years, flat in 10 years, and down 1% in 30 years, ending the week at 65%, 67%, 69% and 91%. AA Muni/AA Corporate ratios were up 1% at 2 and 5 years, flat at 10 years, and down 1% at 30 years to end the week at 64%, 64%, 63% and 81%.
- For the period ending August 30, municipal bond funds reported inflows of $408 million.
- The new issue muni calendar is estimated to be $7.49 billion.
Our take: The municipal market didn’t match last week’s US Treasury rally anywhere but the long end. AAA Muni/Treasury ratios will likely continue to trend higher over the coming months as the support of negative supply (currently -$6.5 billion) evaporates, which will also magnify the impact of fund flows on muni bond valuation. There is no change to our view that the overall direction of the muni market will be largely dependent on changes in the US Treasury curve as the Fed tries to navigate the economy to the 2% target inflation rate without throwing the economy into recession.
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