Weekly Fixed Income Commentary (January 11, 2024)
Economic Commentary
- December CPI and core CPI both rose +0.3%, and rose +3.4% and 3.9% year-over-year, stronger than forecasts of +3.2% and 3.8% respectively. In contrast, PCE prices have been moderating faster than CPI due to differences in weightings, and this is the Fed’s preferred gauge of inflation.
- The December ISM Services index fell from 52.7 to 50.6, almost two points below the 52.5 consensus. Despite being above 50 and still suggesting expansion, the report showed broad weakness and is not strong enough to compensate for the even-weaker ISM Manufacturing survey earlier in the week.
- The NFIB hiring intentions index – which was the best leading indicator of payrolls last year, suggests that private job growth will run at about 150K though the first quarter, but then potentially slow to about 100K early in Q2. The continued rapid drop in temporary jobs also points to slower payroll growth.
- The headline payroll report comprised a 164K increase in private payrolls and a 52K increase in government jobs, in line with the recent trend, which likely will continue for a while yet as state and local government employment catches up with the pre-Covid trend. The trend in private payroll growth continues to slow relentlessly, even after the upside surprise to the December consensus. Permanent job growth outside the health and education sectors, which are driven more by demographics than the business cycle, averaged only 73K in Q4, and even this modest pace likely will be revised down.
- The NY Fed US December 1-year inflation expectations index fell to 3% vs 3.4%, and 3-year inflation expectations fell to 2.6%, the lowest since Dec 2020.
Our take: Recent economic data is mixed. Certain leading indicators of the labor market suggest slowing ahead. Price indices suggest slower progress on inflation, with the word ‘sticky’ rearing its head again. Housing-related components should start to have a meaningful downward impact come Spring. Other components such as car insurance, up a massive 20%, will moderate eventually, as they lag the previous large increase in car prices. At the end of the day, this may push the timing of the first rate cut back from March to May or June but should not significantly alter the cumulative amount of rate cuts over the next 12 to 24 months. As we have recently suggested, interest rates should be range-bound for a few months, until this clear and convincing progress on inflation becomes apparent and allows the Fed to make their first cut.
Corporate Bond Market Commentary
- S. High Yield widened 29 bp last week to an OAS of 368 bp. On a total return basis, HY declined -1.1% on underperformance from CCCs (-1.5%) versus Bs (-1.1%) and BBs (-1%).
- HY primary market activity was tepid last week. Two borrowers tapped the market for just $750 million in total, both to repay outstanding debt.
- HY fund outflows were -$1.3 billion.
- IG spreads widened 5bps to +109 and total returns were -1.24%.
- Thirty-eight issuers sold $56.95 billion of new issue IG bonds and fund flows were +$1.32 billion.
Our take: The wave of issuance we expected right out of the chute in IG has materialized, leaning on rates and spreads. HY issuance has gotten off to a much slower start, which has supported prices of existing bonds, for now. The market is in a bit of a holding pattern, waiting to take its cues from rates, supply/demand technicals, and the all-important earnings season where 2024 guidance should be introduced for most borrowers. Unlike the largely uniform melt-up during the November/December rally, the next few weeks and months should bring about more dispersion and single-name volatility, both good and bad. This would be a welcome development for actively managed fundamental credit picking strategies.
Municipal Bond Market Commentary
- For the week ending January 5, high grade tax-exempt municipal bond yields rose 7, 6, 7 and 8 bps at 2, 5, 10 and 30 years, outperforming US Treasuries across the curve with US Treasury yields rising by 13, 16, 17 and 17 bp at 2, 5, 10 and 30 years.
- AAA Muni/Treasury ratios were unchanged at 2 and 10 years and 1% richer at 5 and 30 years, ending the week at 59%, 57%, 58% and 83%. AA Muni/AA Corporate ratios were lower across the curve, 1% at 2 and 5 years, 2% at 10 years, and 3% richer at 30 years to end the week at 58%, 55%, 53% and 75% respectively.
- For the period ending January 3, municipal bond funds reported outflows of $558 million, comprised of open-end outflows of $335 million and ETF outflows of $203 million.
- The muni new issue calendar is expected to be about $9.4 billion this week.
Our take: Muni ratios remain rich across the curve and continue to be supported by negative net visible supply, though the net supply will likely turn positive early in the new year. 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 Fed rate cuts. Municipal bond yields remain at levels not seen for a decade until recently.
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