Weekly Fixed Income Commentary (November 16, 2023)
Economic Commentary
- Headline CPI was unchanged in October, below the 0.1% consensus, for a 3.2% year-on-year increase. The core CPI (excluding food and energy) rose 0.2%, below the 0.3% consensus expectation, for a 4.0% year-on-year increase. There’s undoubtedly a lot of good news in this report. The 0.2% core increase stopped three months of worrisome acceleration and is close to being consistent with the Fed’s longer-run 2% year-on-year inflation target. The year-on-year core increase is twice the Fed’s 2% target but monthly increases since June are a big improvement from the preceding six months.
- The October retail sales report came in mostly as expected when excluding the noisier components. While the 0.2% increase in control group sales is not incredibly strong, it suggests consumers continued strong summer spending momentum into the fourth quarter despite the resumption of student loan payments. Falling gasoline prices did give households some extra income to spend on everything else, so we’ll have to see if future spending stays strong once gasoline prices stabilize.
- The October PPI fell 0.5%, well below the consensus, +0.1%. Core PPI was unchanged, also below the consensus, 0.3%. The October PPI fell much more than expected from lower energy prices. The “core core” series that excludes food, energy, and trade services rose 0.1%, lower than the 0.2% consensus expectation but basically as expected when factoring in upward revisions to September data.
- House Speaker Mike Johnson’s temporary funding bill passed the House with substantial Democratic support. The move echoes the compromise former Speaker Kevin McCarthy made only months ago that eventually led to his removal. Hardline conservatives are upset with Johnson for not demanding bigger spending cuts, while Johnson claims the stopgap will buy legislators time to negotiate more substantial budgetary changes without the looming threat of a government shutdown causing them to rush.
Our take: Softer CPI and PPI data reinforced the strong move lower in UST rates over the last two weeks, with 10yr and 30yr rates down ~50bp. These data points reinforce market confidence that the Fed is done raising rates this cycle. There will inevitably be fits and starts, both in the economic data and interest rates, but the peak should be behind us, and the trend should be lower. However, the reason for this softer economic data is that the economy is slowing, even before the full lagged effects of higher interest rates have come close to working their way through the economy. Up in quality, out in duration is still the prudent way to position fixed income portfolios. Bonds are still massively cheap relative to equities, and rates would have to come down another ~200bp to justify valuations in the equity markets. A BBB/BB portfolio with a duration of 5 would generate total returns of ~16% over the next 12 months in that kind of mean reversion.
Corporate Bond Market Commentary
- US High Yield tightened 1 bp last week to an OAS of 403 bp. The index now sits 78 bp tight to YE22. On a total return basis, US HY declined -0.3% on underperformance from CCCs (-0.5%) versus Bs (-0.2%) and BBs (-0.3%). On a YTD basis, US HY is now +6.9% with CCCs (+10.9%) still leading Bs (+7.6%) and BBs (+5.5%).
- US HY funds reported a sizeable net inflow of $6.3 billion last week, marking the first weekly inflow in over two months. This trend has continued unabated into the current week, as the $10 billion of inflows for HY funds the past two weeks are the largest on record aside from the two-week period ending 6/3/20’s $12.1 billion.
- US HY primary market activity picked up significantly last week with roughly $8 billion of total volume. This follows a relatively slow October.
- US IG spreads were 3bp tighter to +126, and total returns were -0.04%.
- New issue IG supply was a relatively hefty $44 billion, and fund outflows were $1.5 billion.
Our take: The move lower in rates on softer than expected economic data has triggered a massive flow into HY bonds, driving prices higher and spreads tighter. More rate-sensitive higher quality bonds have benefited the most in this recent rally, hopefully starting the process of rewarding those companies who will be more resilient borrowers through the upcoming economic slowdown. It is vitally important to understand that the reason rates are moving lower is because the economy is slowing; this would not be the right time to chase lower credit quality bonds.
Municipal Bond Market Commentary
- For the week ending November 10, high grade tax-exempt municipal bond yields fell in a parallel shift, falling 10 bps at 2, 5, 10 and 30 years, outperforming US Treasuries by 32, 28, 18, and 9 bps at 2, 5, 10 and 30 years.
- AAA Muni/Treasury ratios fell 6, 5, 4, and 2 percent at 2, 5, 10, and 30 years, ending the week at 67%, 68%, 70% and 90%. AA Muni/AA Corporate ratios fell 4, 4, and 2 percent at 2, 5, and 10 and rose 1 percent at 30 years, to end the week at 66%, 65%, 65% and 82% respectively.
- For the period ending November 1, municipal bond funds reported outflows of $151 million, with muni ETF inflows of $1 billion and open-end mutual fund outflows of $1.2 billion.
- The new issue muni calendar is estimated to be $8 billion.
Our take: It was a rare week that the muni market rallied across the curve even as US Treasury yields went up. History says this will likely correct in the near future but we maintain that this is an opportune time to invest in high grade municipals as after-tax yields remain elevated, the Fed appears to be done hiking, and predictions are for negative net supply in December.
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