Weekly Fixed Income Commentary (October 12, 2023)
Economic Commentary
- Last Friday’s employment report, with 455k jobs created between the 336k headline and the 119k revision, was strong on the surface. However, all of the revisions were in government jobs, and for the full quarter, full-time jobs contracted 692,000 and part time jobs increased 1,155,000.
- Average hourly earnings rose 0.2%, less than the 0.3% consensus again, resulting in a decline in the year-on-year pace of pay growth from 4.3% to 4.2%.
- While Fed governors have begun to talk about how the rise in long term interest rates is tightening financial conditions and helping them do their work, which we agree with, they are still at risk of overtightening and causing a harder landing. The irony to us is that the recently released Fed minutes were the first time all year that the word ‘recession’ didn’t appear at all, just when many of the leading indicators and corporate management comments are signaling just that.
- Today’s CPI release will be used to set the cost-of-living adjustment for 2024 at 3.2%, down from 8.7% in 2023 and 5.9% in 2022. This deceleration will be another drag on the consumer already facing a myriad of other headwinds – higher prices, the resumption of student loan repayments, dwindling savings that had accumulated during the pandemic from stimulus and lack of spending to name a few.
Our Take: Mixed signals on inflation and the labor market require digging under the surface and thinking about where the puck is going. The labor market is surprisingly strong, but wages are contained, and the mix is part time and temp jobs – is that sustainable? Inflation is declining, but the pace of declines is slowing – does that mean it’s going back up or will just take longer to get to the 2% target? Policy acts with a lag, and the recent increase in the long end of the yield curve will help reverberate this transmission mechanism and perhaps shorten the lags. The Fed will win, one way or another – failure is not an option for them – so the higher short-term and long-term rates have to go and the longer they need to remain high, the harder the eventual fall will be.
Corporate Bond Market Commentary
- US High Yield widened 30 bp last week to an OAS of 433 bp. On a total return basis, US HY declined -1.4% reflecting broad-based negative performance from CCCs (-1.7%), Bs (-1.4%) and BBs (-1.2%). On a YTD basis, US HY is now +4.6% with CCCs (+11.2%) leading Bs (+5.3%) and BBs (+2.6%).
- HY funds reported a sizeable net outflow of $2.6 billion last week.
- US HY primary market activity slowed to a standstill amidst the volatility and fund outflows.
- Investment Grade spreads were 5bp wider to +129bp and total returns were -1.45%.
Our take: Last week’s volatility, sparked by rate increases that triggered the negative performance -> fund outflows feedback loop, was interrupted by the unimaginable geopolitical events in the Middle East which triggered a flight to safety in Treasuries. Constructive commentary from FOMC governors added to the positive sentiment and rate-sensitive bonds have rallied, although they are still well-below recent highs. Further stability in rates markets should allow the power of the coupon – attractive yields on high quality bonds – to shine through and rebuild fixed income returns.
Municipal Bond Market Commentary
- For the week ending October 6, 2023, high grade tax-exempt municipal bonds yields rose 11, 11, 12 and 12 bps higher at 2, 5, 10, and 30 years, underperforming US Treasuries by 2 bps at 2 years and outperforming by 3, 11, and 15 bps at 5, 10 and 30 years.
- AAA Muni/Treasury ratios rose 2% at 2 years, were unchanged at 5 years, and fell 1% and 3% in 10 and 30 years, ending the week at 74%, 73%, 74% and 91%. AA Muni/AA Corporate ratios followed a similar pattern, up 1% at 2 years, flat at 5 years, and down 1% and 2% at 10 and 30 years to end the week at 72%, 70%, 69% and 82% respectively.
- For the period ending October 4, municipal bond funds reported outflows of $1.274 billion.
- The new issue muni calendar is estimated to be $5.1 billion.
Our take: While we see still see headwinds to municipal relative value, the muni market continues to be dominated by 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. There has been a flight to quality following last weekend’s terrorist attacks by Hamas in Israel, but future economic releases will either provide support for or mute the effect of the flight to quality rally.
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