Weekly Fixed Income Commentary (October 27, 2023)
Economic Commentary
- US GDP grew 4.9% in Q3 and personal consumption increased 4.0%.
- The Fed released its semi-annual Financial Stability Reportlate last week. Among many notable points, the report shows that the Fed’s survey contacts are increasingly worried about the risks from persistent inflation and monetary tightening, rising from 56% in May to 72% in October.
- The Eurozone is looking recessionary as PMIs show further weakness in October. Bloomberg EconomicsQ3 GDP Eurozone Nowcast stands at ‑0.1%
- The Chinese yuan is under pressure. China sold a record number of US Treasuries last month to raise cash to buy its own currency. With the domestic Chinese economy slumping thanks to the collapse of its real estate companies and weakening exports, China desperately needs foreign investment.
Our take: How long can the US economy diverge from the pronounced slowdown in activity taking place around the world? How long can US consumers spend more above their means, particularly in the face of higher interest rates? When will CEO & CFO confidence wane enough for companies to bite the bullet and lay off workers to protect margins which are getting squeezed? The particularly strong Q3 GDP number feels like a final surge before the capitulation. Leading indicators have been telling us we are already on our way. Once the concurrent indicators corroborate the trend, rates will go lower across the curve.
Corporate Bond Market Commentary
- US High Yield widened 22 bp last week to an OAS of +452 bp. On a total return basis, US HY declined -1.2% reflecting broad-based negative performance from CCCs (-1.5%), Bs (-1.2%) and BBs (-1.2%).
- US HY primary market activity was modest last week, bringing MTD total volume to ~$7 billion.
- US IG spreads were 6bp wider to +133 bp and total returns were -1.94%.
- HY funds saw outflows of $1.9 billion and IG funds had outflows of $2.3 billion last week.
Our take: Bond markets were volatile, and performance was negative, as the sharp move higher in rates drove continued outflows and risk-off sentiment, finally reflected in High Yield spread widening; however, spreads remain arguably too tight by many historical standards. Until we get some stability in rates, it will be challenging for credit to string together several days or weeks of total return performance. Earnings season is off to a mixed start, and disappointments are being punished more severely than recent quarters, a further indication of deteriorating sentiment and technical factors. Up in quality for IG and BB rated credits still remains the sweet spot for risk adjusted returns.
Municipal Bond Market Commentary
- For the week ending October 20, 2023, high grade tax-exempt municipal bonds yields rose 19, 21, 23 and 26 bps at 2, 5, 10, and 30 years, underperforming US Treasuries by 17 bps at 2 years and outperforming by 1, 7, and 7 bps at 5, 10, and 30 years.
- AAA Muni/Treasury ratios rose 3% at 2 years and 1% at 5 years, were unchanged at 10 years, and fell 1% in 30 years, ending the week at 74%, 73%, 74% and 91%. AA Muni/AA Corporate ratios rose 2% at 2 years, 1% at 5 and 10 years, and were unchanged at 30 years to end the week at 71%, 69%, 68% and 82% respectively.
- For the period ending October 18, municipal bond funds reported outflows of $297 million, with muni ETF inflows of $246 million and open-end mutual fund outflows of $543 million.
- The new issue muni calendar is estimated to be $9.8 billion.
Our take: After the prior week’s brief break the 6-month-old US Treasury bond selloff resumed last week, carrying the municipal market in its wake. 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, but should the US Treasury market stabilize we believe this may be an opportune time to buy high grade muni bonds. 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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