Weekly Fixed Income Commentary (June 6, 2024)
Economic Commentary
- Job openings fell sharply to 8.059 million, with the ratio of openings to unemployed workers now down to pre-Covid levels. The hiring, quits, layoff and separation rates all remained flat. All of this is consistent with a better balance between supply and demand in the job market, but not outright weakness. Looking at the details, one thing that stood out is that openings declined in all three of the sectors that are still playing “catch up”: private education & health care, leisure & hospitality and government. This suggests that hiring in these sectors, and so total job growth, should continue to moderate in coming months.
- The May ISM Manufacturing fell from 49.2 to 48.7, missing the 49.5 consensus expectation by eight tenths of a point. The headline index has shifted downward over the past two months after moving briefly into expansionary territory in March. The May survey showed a deep contraction in new orders in particular, which tumbled from 49.1 to 45.4, the lowest in a year. Prices paid fell 3.9 points in May, from 60.9 to 57.0, slowing for the first time in four months as supply chain improvements and a manufacturing rebound in China continue to ease price pressures.
- The ISM services index rose to 53.8, a rebound from the 49.4 in April. Business activity and new orders were strong, while the employment component was weak at 47.1.
- The April PCE deflator rose 0.3% headline and 0.2% core, exactly as expected. The year-on-year increases, 2.7% headline and 2.8% core, were both the same as in March and also as expected.
- The ECB cut rates but given recent inflation setbacks, signaled that future cuts are uncertain, in what is being described as a hawkish cut.
- Unit labor costs rose 4%, down from 4.7% last month and well below the 4.9% expectation.
Our take: Treasuries have rallied sharply over the last week, even though economic data has been relatively mixed. The market is again trying to get out in front of a slowing in the economy which would justify an earlier rate cut. While there are signs of cooling, many of these data points are secondary and tertiary indicators and could be just another head fake. Employment is cooling somewhat, but perhaps just coming into better balance rather than heading into outright declines. It is still a full-employment economy where people should be confident that they will remain employed or quickly be able to get another job if laid off. We still expect a trading range in UST rates for the time being and will trim a bit of duration if rates plumb the lower end of the range, but for now we are comfortable with higher quality duration.
Corporate Bond Market Commentary
- IG spreads tightened 1bp last week back to recent tights of +88bp. However, rising rates pushed yields higher and total returns were only +0.04%.
- Fund flows were -$1.419 billion.
- New issue supply was $19 billion. NICs were 5bps, wider than the 3.3bps YTD average, and order books were 2.8x covered, down versus the 3.8x YTD average.
- HY spreads widened 9bp to +320bp and total returns were -0.03%.
- Fund flows were -$917 million.
- Only one new deal priced last week for $900 million, pushing May total volume to $31.3 billion.
Our take: Uneventful corporate bond performance last week has turned to stronger performance this week on the back of the strong move lower in rates. The new issue market remains wide open so catalyst-driven trades are still appropriate as a complement to our barbell approach of higher quality duration via IG and strong BBs plus selective Bs and CCCs where our deep dive fundamental analysis finds contrarian ideas where we believe the credit is improving yet still not recognized by the broader markets.
Municipal Bond Market Commentary
- The week ending May 31 was another slow week for economic data but even with a smaller issuance calendar supply outstripped demand pushing muni yields and ratios higher. AAA muni yields were 8, 12, 10 and 13 bps higher at 2, 5, 10, and 30 years. The AAA municipal bond curve underperformed US Treasuries where yields fell 7 and 2 bp at 2 and 5 years and rose 3 and 8 bp at 10 and 30 years.
- AAA Muni/Treasury ratios were up 3% at 2 and 5 years, 2% at 10 years, and 1% at 30 years, to end the week at 69%, 70%, 69% and 86% at 2, 5, 10, and 30 years. AA Muni/AA Corporate ratios also rose, 2% at 2, 5 and 30 years while holding steady at 10 years, ending the week at 69%, 68%, 65% and 79% at 2, 5, 10 and 30 years.
- For the weekly period ending May 29, Lipper reported municipal bond fund outflows of $89 million.
- A very large muni new issue calendar is expected to be around $16.7 billion this week.
Our take: The US Treasury and municipal bond markets remain range bound. Traders will be focused on Friday’s Nonfarm Payrolls data, next week’s FOMC meeting, and market supply & demand technicals. Though ratios rose again this week, municipal bonds remain rich relative to US Treasuries and we expect continued upward pressure on US Treasury/AAA muni ratios if new issuance calendars remain large.
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