Weekly Fixed Income Commentary (September 14, 2023)
Economic Commentary
- August retail sales of +0.6% beat consensus expectations, but a big July downward revision meant the level of spending was close to what was expected. Additionally, price changes in the components making up retail spending exaggerated the rise, as inflation-adjusted retail spending was not nearly as strong, falling -0.24%.
- This week’s CPI report was a great example of when worse-than-expected is still pretty good. The +0.6% headline increase in the CPI was the biggest since a 1.2% increase last June thanks to rising gasoline prices, and the +0.28% core increase was bigger than the +0.2% consensus forecast or the +0.16% rise in the core in both June and July. And yet, if not for June and July, the rise in August would have been the smallest since October 2021 and the 3-month annualized increase was the lowest since April 2021.
- PPI rose +0.7% headline (energy popped more than expected) and +0.3% ex-food, energy, and trade services. Year-on-year increases in the PPI ex FE&TS accelerated from +2.7% to +3.0% in August. PPI inflation has generally improved for more than a year. The August increase in the core was the second consecutive. The July increase was the first since it fell from 7.1% in March 2021 to 2.7% in June.
- The UAW contract with Ford, GM and Stellantis expires tonight, and the UAW is expected to begin targeted strikes, which would broaden out if progress is not made. This will have both real and psychological impacts on the economy, particularly in regions where assembly and parts factories are located.
Our take: The bond market reaction so far suggests that a +0.28% core CPI increase was within a range investors view as low enough for the Fed to leave rates unchanged next week, and not high enough to change expectations inflation is trending in the right direction. The updated dot plots will offer clues on FOMC members’ views on higher for longer. We believe the underlying economy is slowing more than is readily apparent and take the under on how long the Fed will need to hold rates at these levels.
Corporate Bond Market Commentary
- US High Yield widened 4 bp last week to an OAS of 385 bp. On a total return basis, US HY was down 0.3% reflecting weak performance for BBs (-0.4%) and Bs (-0.3%) versus CCCs (+0.1%). On a YTD basis, US HY is now +6.9% with CCCs (+13.9%) leading Bs (+7.5%) and BBs (+5%).
- HY funds reported a net inflow of $252 million last week.
- US HY primary market activity resumed following the Labor Day holiday with over $1 billion of total issuance. The new issue calendar is growing, with more than $4 billion of bonds being marketed. Companies are looking to take advantage of the current risk-on sentiment before either interest rates go higher or spreads go wider.
- IG spreads were 1 wider to +123 bp and total returns were -0.28%. 35 companies priced $55.5 billion as the post-Labor Day deluge was unleashed. This week should see an additional $30 billion or more of supply.
Our take: The bond markets are absorbing the large amount of new issue supply quite well and in an orderly manner, which should bring other issuers off the sidelines. Many of the new deals are mandatory rather than opportunistic – due to a pending M&A transaction or refinancing imminent maturities. All in yields need to go lower to encourage more opportunistic issuers to tap the markets. Q3 earnings season will be the next test for the corporate bond market, and the potential for dispersion and downside volatility is increasing, favoring managers who are good credit pickers.
Municipal Bond Market Commentary
- For the week ending September 8, 2023, high grade tax-exempt municipal bonds yields were 2, 2, 4 and 5 bps higher at 2,5,10, and 30 years, outperforming US Treasuries by 9, 8, and 5 bps at 2, 5, and 10 years, and underperforming by 1 bp in 30 years.
- AAA Muni/Treasury ratios fell 1% in the 2 and 5 year and were unchanged at 10 and 30 years, ending the week at 64%, 66%, 69% and 91%. AA Muni/AA Corporate ratios were down 1% at 2 years, flat at 5 and 10 years, and up 1% at 30 years to end the week at 63%, 63%, 64% and 82%.
- For the period ending September 6, municipal bond funds reported outflows of $2.4 billion, with ETFs seeing inflows of $199 million and open-end fund outflows totaling $2.6 billion.
- The new issue muni calendar is estimated to be a below average $7.3 billion.
Our take: The municipal market seems to be oscillating around the moves of the US Treasury market, underperforming with ratios rising one week only to reverse the pattern the next week. The net effect is that relative value has changed little over the last few months as US Treasury rates have risen. We still anticipate that AAA Muni/Treasury ratios will likely continue to trend higher over the coming months as new issue supply is expected to exceed reinvestment of called and maturing securities. There is no change to our view that 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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