Weekly Fixed Income Commentary (December 19, 2024)
Economic Commentary
- The flash composite PMI rose to 56.6 in December, from 54.9 in November, above the consensus, 55.1. The services PMI increased to 58.5, from 56.1, well above the consensus, 55.8. The manufacturing PMI fell to 48.3, from 49.7, below the consensus, 49.5.
- The Empire State manufacturing index plunged to +0.2 in December, from +31.2 in November, below the consensus, +10.
- Housing starts dropped to 1,289K in November, from 1,312K, below the consensus, 1,345K. Building permits jumped to 1,505K, from 1,419K, above the consensus, 1,430K. New single-family construction will come under further pressure in the coming months, as permits have been running well ahead of new home sales for some time, suggesting that homebuilders have overestimated the strength of demand. New residential construction activity looks set to decline sharply.
- Headline retail sales rose by 0.7% in November, slightly above the consensus, 0.6%. Net revisions were +0.1%. Sales ex-autos increased by 0.2%, a bit below the consensus, 0.4%. Net revisions were negligible. Control retail sales rose by 0.4%, in line with the consensus. Net revisions were +0.1%. The headline number was inflated by a 2.8% jump in auto sales, which probably reflects a rush to replace vehicles damaged by hurricanes earlier in the fall, rather than a genuine pick-up in underlying demand.
- The Fed cut rates 25bp. The updated Summary of Economic Projections (dot plots) implies just two cuts in 2025. Newcomer Cleveland Fed President Beth Hammack dissented in favor of not cutting rates. The only change in the statement was the addition of the phrase “the extent and timing of” when discussing potential future rate cuts, which introduces the possibility of skips at future meetings.
- Q3 GDP was revised from 2.8% to 3.1%.
- The Philly Fed business outlook survey fell from -5.5 to -16.4, well below the 2.8 expectation.
- Jobless claims fell 22k from 242k to 220k, and continuing claims of 1841k were below expectations of 1892k.
Our take: A hawkish 25bp cut accompanied by dot plots revised to show a stronger economy and fewer cuts should not have surprised anyone. Yet interest rate markets were spooked higher, and the curve steepened the most since 2022. This rate spike also caused corporate bond spreads to crack, at least a little bit so far. Bond markets are now pricing in only ~1.5 cuts in 2025, a sharp reversal from earlier this year. Some of this is due to an economy that proved more resilient in the face of rate hikes, powered by lingering fiscal stimulus and the wealth effect – and another factor is the Trump victory and republican control of congress. We think the rates market has corrected a bit too far, as fiscal stimulus is waning quickly, and wealth-powered confidence can be fleeting if equity markets hiccup. Additionally, the new administration faces the challenge of enacting legislation amongst a very narrow majority that is replete with internal disagreement even within the republican party over priorities and fiscal discipline. Our increased rate hedges have helped cushion the blow of this rate spike somewhat, but we are wary of what a runaway steepening curve could do to all risk assets. We are getting closer to levels where adding a bit more duration might make sense, with the expectation that the outlook is cloudy so trading the range will be a better strategy than a set and hold stance.
Corporate Bond Market Commentary
- IG spreads were 3bp tighter to +78bp and total returns were -1.31%.
- Fund flows were +$1.918 billion.
- New issue supply was $18 billion, in a last gasp before the seasonal shutdown.
- HY spreads were 1bp wider to +268bp and total returns were -0.31% (BBs -0.43%, Bs -0.27%, CCCs +0.09%).
- Fund flows were +$747 million.
- New issue supply was $6.35 billion, and will be very modest this week before shutting down for the year.
Our take: It has been a while since spreads have cracked. While markets were somehow surprised by a more hawkish Fed message as the catalyst, it was bound to be something that caused at least a modest backup in spreads given how tight they are. A lack of trading liquidity for the remainder of the year could exacerbate the selloff, as fewer traders are in their seats, and those that remain will likely seek to protect their performance for the year and not give back too much. This creates the opportunity to buy bonds more cheaply, and position for the typical January effect, which should hold true following a weak December. We have had a purposefully larger cash balance in preparation for such a possibility, and will methodically deploy some of it over the balance of December.
Municipal Bond Market Commentary
- The week ending December 13 saw a bond selloff across the curve. AAA muni yields were up 10, 14, 14, and 18 bp at 2, 5, 10 and 30 years while the US Treasury yields were up 14, 21, 24, and 27 bp at 2, 5, 10 and 30 years.
- AAA Muni/Treasury ratios were unchanged at 2 and 5 years and down 1% at 10 and 30 years to end the week at 62%, 63%, 66% and 79%. AA Muni/AA Corporate ratios were up 1% at 2, 5 and 30 years and unchanged at 10 years to end the week at 63%, 62%, 63% and 76% at 2, 5, 10 and 30 years.
- For the period ending December 11 municipal bond funds had outflows of $316 million, marking an end to nearly 6 months of consecutive weekly inflows.
- Muni issuance is expected to be a paltry $2.6 billion as the holiday season takes a toll on the new issue calendar.
Our take: The big economic numbers of the week were CPI which came at expected levels and PPI which came at higher than expected levels. PCE, the Fed’s favorite measure of inflation, is the biggest economic number left between now and year end. Rate markets continue to be volatile as participants try to read the tea leaves of Fed monetary policy, Trump’s upcoming fiscal policy, and multiple conflicts across the world. Municipal bond relative value technicals continue to be strong with digestible issuance, and in spite of this week’s outflow we expect strong fund flows will likely return.
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