Weekly Fixed Income Commentary (December 8, 2023)
Economic Commentary
- Chair Powell’s final appearances on Friday before the pre-FOMC silent period cemented expectations for the Fed to leave rates unchanged at the December 13 meeting. His insistence that it’s premature to rule out future rate hikes fell on deaf ears. Markets have moved on from the possibility of another rate hike and are continuing to price in more aggressive 2024 rate cuts with each week that shows cooling economic activity.
- The November ISM Services index rose from 51.8 to 52.7, above the 52.3 consensus. Overall, the report suggests enough demand and economic activity in the service sector to compensate for the weaker goods side of the economy captured by the ISM Manufacturing survey last Friday.
- The number of job openings fell from 9.35 million in September to 8.73 million in October, a nearly 600k miss versus the 9.3 million consensus expectation and lower than every estimate in the Bloomberg News survey. Quits fell too from 3.646m to 3.628m, in another sign the job market is less strained. The ratio of job openings to unemployed people slid to 1.3x, the lowest since mid-2021 and almost back to the pre-pandemic norm of ~1.2x.
- The Citi economic surprise index has declined from ~63 in late October to ~12 today.
- The Atlanta Fed GDPNow forecast for Q4 is down to only +1.273%.
Our take: The economy continues to slow, and now the labor market is beginning to catch up. The leading indicators have been signaling this for a while, and now more of the concurrent indicators are confirming the trend. Although financial conditions have eased, the Fed is showing no near-term inclination to cut rates, raising the risk of an over-correction and harder landing. Rates have moved a lot lower, and perhaps have come down a little too much, too soon, but the overall trend will continue. Any significant pullback in rates is another opportunity to add duration, particularly in the 5–10-year portion of the curve.
Corporate Bond Market Commentary
- US High Yield widened 2 bp last week to an OAS of 387 bp. The index now sits 94 bp tight to YE22. On a total return basis, US HY climbed 1.4% on broad-based positive performance from BBs (+1.5%), Bs (+1.3%) and CCCs (+1.6%).
- US HY primary market activity resumed last week with roughly $3 billion of total volume. This brought the November total to over $19 billion, a significant increase from the October total of ~$9 billion. YTD volume now totals ~$163 billion.
- Fund flows into HY were +$739 million.
- Investment grade spreads were -3bp to +111bp and total returns were +2.21%.
- New issue supply was $17.2 billion and fund flows were -$789 million.
Our take: Strong performance in HY and IG credit continued last week, even despite lackluster fund flows. Declining rates have been a tailwind for sure, but spreads have also tightened and have reached relatively snug levels. From here, either lower-rated credit will catch up and compress (we don’t think so given our economic outlook), or higher quality credit spreads might leak a little. However, any spread widening at the higher quality segment should be cushioned by further declines in treasury yields, such that forward total returns will still be compelling both on a relative and absolute basis.
Municipal Bond Market Commentary
- For the week ending December 4, high grade tax-exempt municipal bonds yields fell once again in a nearly parallel shift, falling 28, 31, 31 and 28 bps at 2, 5, 10 and 30 years, underperforming US Treasuries on the short end and outperforming on the long end with US Treasury yields falling by 41, 36, 27, and 21 bps at 2, 5, 10 and 30 years.
- AAA Muni/Treasury ratios fell 1-3 percent at 2, 5, 10, and 30 years, ending the week at 62%, 62%, 63% and 85%. AA Muni/AA Corporate ratios fell 1-4 percent across the curve to end the week at 60%, 58%, 57% and 78% respectively.
- For the period ending November 29, municipal bond funds reported outflows of $65 million
- The new issue muni calendar is expected to be $9.78 billion.
Our take: Muni ratios have continued to richen in recent weeks, supported by negative net visible supply of -$8.5 Billion on the visible calendar per Bloomberg on 12/1/23. This will likely persist through the holidays, but it is likely that ratios rebound and municipals underperform US Treasuries in early 2024 unless the muni market draws increased support from fund inflows.
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