Weekly Fixed Income Commentary (December 28, 2023)
Economic Commentary
- The core PCE deflator came in at +0.1% MoM (actually +.06% out to 2 decimals), pushing the YoY rate down to just 3.2%, the lowest since April 2021. Moreover, in the three months to November compared to the previous three months, the core deflator only rose 2.1%, approaching the 2% target, and already below the Fed’s year-end 2024 target of 2.4%.
- Q3 GDP was revised downward from 5.2% in the previous report to 4.9%; not a big deal either way as this is already well in the rearview mirror.
- The December Philly Fed manufacturing index fell to -10.5 from -5.9, below the consensus forecast of -3.0. The 4.6-point decline in the headline index follows the 23.6-point plunge in the December Empire State manufacturing index, suggesting that manufacturing continues to struggle. The other regional surveys are painting a mixed picture – manufacturing components generally weak and non-manufacturing (services) generally firmer. The national ISM manufacturing index stood at just 46.7 in November, only 0.7 points above the cycle low reached in June.
- Last week, initial jobless claims rose slightly to 205K from 203K, below the consensus, 215K. Continuing claims were little changed at 1,865K, also below the consensus, 1,880K. Initial claims remain extremely low, but continuing claims have risen markedly since late September, suggesting that people who have been laid off are finding it harder to secure new positions.
Our take: Economic conditions continue to illustrate a generally slowing economy and tamer inflation readings. However, the big move lower in rates has incorporated much of this. The key question for bond markets in 2024 is how much is now priced in? The answer will depend on if inflation continues to decline, if the relative strength in services prices rolls over and contributes to disinflation, and how quickly housing-related declines push inflation down further. Interest rates have likely reached a level where they will be range-bound for a few months, until the data further corroborates the trend, and the Fed readies its first actual cut. A surge in corporate and treasury supply right out of the chute in January could push rates temporarily higher as well.
Corporate Bond Market Commentary
- Bond markets are quiet this holiday season – a lull after a massive rally.
- Last week, IG spreads were unchanged and total returns were -0.16%.
- US HY spreads were 12bp tighter to +324bp and total returns were +0.67%.
- No new issue supply in either IG or HY.
Our take: We expect a deluge of new issue supply in January, with issuers taking advantage of the significant move lower in borrowing costs to pre-fund 2024 or even 2025 maturities. This supply will likely pressure both UST rates and spreads, especially in IG. We have trimmed some positions into the significant strength of the rally, raising some dry powder to take advantage of juicy concessions in the new issue bonanza.
Municipal Bond Market Commentary
- For the week ending December 22, high grade tax-exempt municipal bonds yields continued to rally, falling 3, 4, 5 and 5 bps at 2, 5, 10 and 30 years, underperforming US Treasuries at the 2 year, matching at the 5 year and outperforming at 10 and 30 years with US Treasury yields falling by 12, 4, and 2 bp at 2, 5, and 10 and rising 4 bp at 30 years.
- AAA Muni/Treasury ratios cheapened by 1% at 2 years, richened by 1% at 2 and 10 years and richened 2% at 30 years, ending the week at 58%, 57%, 59% and 84%. AA Muni/AA Corporate ratios cheapened 1% at 2 years, were unchanged at 5 and 10 years and 2% richer at 30 years to end the week at 58%, 56%, 55% and 78% respectively.
- For the period ending December 20, municipal bond funds reported outflows of $147 million.
- There are no new issues scheduled for the week between Christmas and New Years.
Our take: Muni ratios remain rich across the curve and continue to be supported by negative net visible supply. The primary direction of the muni market will continue to be dictated by changes to the US Treasury curve, especially as inflation and related data feed into the market’s expectations of future Fed actions. In spite of the large recent rally, municipal bond yields are still near levels not seen for a decade until recently.
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