Weekly Fixed Income Commentary (February 27, 2025)
Economic Commentary
- Jobless claims rose 22k to 242k, likely reflecting at least some of the federal workers let go in the first round of layoffs, though it could also reflect Los Angeles residents affected by the massive fires in the city. State level data next week will make it easier to clarify where the job losses were. Another, deeper round of federal job cuts is planned in April, this one directed by agency heads.
- S&P Services PMI declined to 49.7, below expectations of 53.0, and composite PMI declined to 50.4, below the 53.2 consensus.
- Durable goods orders rose 3.1%, mostly thanks to a rebound in civilian aircraft orders after a couple of turbulent months.
- The labor market differential – those reporting jobs plentiful minus those reporting jobs are hard to get fell to 17.1, one of its lowest since the spring of 2021. Job growth has been fine and the unemployment rate has moved horizontally since last summer but hiring rates and quit rates are well below the pre-pandemic norms.
- US housing starts and existing home sales both came in relatively weak, with housing starts down -9.8% m/m and existing home sales down -4.9% m/m.
- 2-year break-evens are up 38bp since the inauguration, a sign that tariffs (or tariff threats) are elevating short-term inflation expectations. 5-year/5-year forward break-evens, choppy as they may be, are down a few basis points, suggesting bond investors expect any tariff-induced increase in prices will be short-lived.
- Consumer sentiment fell more than three points in Friday’s preliminary U Michigan survey, but the real shocker was the highest reading in 5-10-year ahead inflation expectations since 1995 at 3.5%. The Conference Board consumer survey also revealed similar degradation in consumer confidence, with expectations declining from 83.9 to 72.9.
- Treasury Secretary Scott Bessent’s appearance on Bloomberg TV explained why he feels higher coupon issuance is a “long way off.” From his perspective, President Trump’s policies will lower inflation and reduce the deficit towards the end of this year, precluding any urgency for higher long-term Treasury issuance. This alleviated concerns about rising supply of Treasury borrowing and bolstered the recent rally in US Treasury bonds.
Our take: Recent economic data has triggered concern about slowing economic activity, and this has overtaken inflation concerns for the bond market and pushed interest rates lower. While the new administration would like lower interest rates, this is not the way they would hope to achieve them. DOGE cuts have just begun, and the knock-on effects on reduced spending and federal employment will take time to play-out. In the meantime, regional PMI surveys are weak, employment is at best sideways if not cooling, the housing market is plumbing new recent lows, and consumer confidence is waning. Concurrently, potential tariffs are creating uncertainty for businesses and consumers, further shaking confidence and muddying the waters. As we have been writing, it will take some time for all of this to play out and for the economic data to become clearer. In the meantime, rates have declined substantially and actively trading the range by saying thank you and trimming a bit of duration seems prudent. While economic growth concerns are not invalid, the stimulative policies such as regulatory reform and the extension of tax cuts have yet to be implemented, and a hard landing seems unlikely for the foreseeable future.
Corporate Bond Market Commentary
- IG spreads widened 1bp to +81bp and total returns were +0.30%.
- New issue supply roared back, with $30 billion last Tuesday alone, to push the total to $52.3 billion total. Order books averaged 4.2x oversubscribed, new issue concessions were only 3bp and attrition was only 17%, well below recent trends.
- Fund flows were -$1.022 billion.
- HY spreads widened 16bp to +278bp and total returns were -0.02% (BBs -0.07%, Bs -0.02%, CCCs +0.14%).
- New issue supply was $3.1 billion.
- Fund flows were +$1.298 billion.
Our take: The investment grade bond market is performing well despite the wave of new issuance, supported by favorable demand technicals. Attractive all-in yields and lower hedging costs continue to attract traditional and non-traditional investors into the IG bond market. In the high yield market, new issue supply has not yet ramped-up. The expected tsunami of merger and acquisition driven issuance has not materialized, yet. It will take a bit of time, as management teams and boards of directors are likely trying to navigate tariff and other uncertainty before taking on major corporate transactions. In the meantime, growth slowdown concerns in the UST market have not yet cracked high yield spreads. If those concerns linger a little while longer, we expect that they will push high yield bond spreads wider, especially for the lower credit quality cohort in more cyclical industries.
Municipal Bond Market Commentary
- Muni and US Treasury yields fell slightly over the week ending February 21. AAA muni yields were down 2, 4, 3, and 1 bp at 2, 5, 10 and 30 years while US Treasury yields were down 6, 5, 4, and 2 bp at 2, 5,10 and 30 years.
- AAA Muni/Treasury ratios were unchanged, ending the week at 62%, 64%, 67% and 85% at 2,5,10 and 30 years. AA Muni/AA Corporate ratios rose 1% at 2 years and were unchanged at 5, 10 and 30 years to end the week at 64%, 62%, 63% and 77% at 2, 5, 10 and 30 years.
- Municipal bond funds had inflows of $546 million for the weekly period ending February 19.
- Muni issuance is expected to be around $6.6 billion this week.
Our take: Positive fund inflows and a moderate new issuance calendar continue to support the rich relative value of municipal bonds. Muni fund flows and new issuance will be monitored closely over the next several months as reinvestment dollars drop seasonally.
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