Weekly Fixed Income Commentary (October 19, 2023)
Economic Commentary
- Retail sales rose 0.7% in September, easily beating the consensus forecast of 0.3%. Coupled with a +0.2% upward revision to +0.8% in August, retail spending is not yet showing signs of rolling over.
- A weak 30-year UST auction reinforced upward yield momentum at the long end of the curve and marked the third consecutive tail in a coupon auction over the last couple weeks.
- The 30-year mortgage rate exceeded 8% for the first time since 2000 and existing home sales sank to their lowest level since 2010.
- Jerome Powell’s remarks at the Economic Club of NY, the last before the blackout period starts on Saturday, were of a cautious tone and acknowledged the risks and uncertainties from the cumulative tightening of past rate increases, the rising yields at the long end of the curve, and geopolitical tensions.
Our take: In a period of relatively scant economic data, the strong retail sales figures helped push rates higher. Coupled with technical factors such as lack of demand from foreign buyers and an increasing supply, treasuries continue to be under severe pressure, particularly at the long end of the curve. As Dallas Fed President Lorie Logan recently noted, these rising term premiums are akin to significant additional tightening of financial conditions, which could obviate the need for additional rate hikes. This will continue until either the economy starts to show evidence of slowing, or the geopolitical situation worsens and triggers a flight to safety bid. The former could take a bit, but the latter unfortunately could happen at any hour now.
Corporate Bond Market Commentary
- US High Yield tightened 3 bp last week to an OAS of +430 bp. On a total return basis, US HY climbed +0.7% reflecting broad-based positive performance from CCCs (+0.7%), Bs (+0.6%) and BBs (+0.7%).
- HY funds reported a net outflow of $2.5 billion last week, the third consecutive >$2 billion withdrawal totaling $8.1 billion over the last five weeks and ~$7 billion from ETFs which represents 11% of AUM. The past 4 weeks are also the largest stretch of HY mutual fund outflows since August 2014.
- US HY primary market activity picked up modestly last week with $2.7 billion of total volume.
- IG spreads were -2bp tighter and total returns were +1.23%. IG funds saw $1.13 billion of inflows and $13 billion of issuance.
Our take: Like a broken record, we highlight the very compelling all-in yields on high quality bonds. With IG > 6% and HY approaching 10%, these are levels where historically 12-month average forward returns are strongly in the double-digits. For those on the sidelines or with cash in reserve, start legging into some quality fixed income now and be prepared to add more when the top in rates is clear.
Municipal Bond Market Commentary
- For the week ending October 13, 2023, high grade tax-exempt municipal bonds yields fell 18, 16, 16 and 17 bps at 2, 5, 10, and 30 years, outperforming US Treasuries by 15 and 4 bps at 2 and 5 years and underperforming by 3 and 5 bps at 10 and 30 years.
- AAA Muni/Treasury ratios dropped 3% at 2 years and 1% at 5 years, were unchanged at 10 years, and rose 1% in 30 years, ending the week at 71%, 72%, 74% and 92%. AA Muni/AA Corporate ratios fell 3% at 2 years, 2% at 5 and 10 years, and were unchanged at 30 years to end the week at 69%, 68%, 67% and 82% respectively.
- For the period ending October 11, municipal bond funds reported outflows of $781 million, with muni ETF inflows of $518 million being outpaced by open-end mutual fund outflows of $1.3 billion.
- The new issue muni calendar is estimated to be $12.2 billion.
Our take: We had a brief break in the bond market sell-off that began nearly 6 months ago, likely a flight to quality over fear that hostilities in Israel could expand into a larger conflict. No changes to our view of hurdles to municipal relative value that include the seasonal new issue supply exceeding reinvestment capital and fund outflows related to the rising rates detrimental impact on returns. Overall, the greatest impact on the muni market continues to be 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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