Economic Commentary
- As widely expected, the Fed raised interest rates 25bp to their highest level in 22 years. Jerome Powell again indicated that the FOMC will be data dependent as they determine the path of rates going forward.
- Markets are pricing-in a cumulative probability of ~40% of one additional 25bp hike across September or November, and 5+ cuts in 2024.
- The preliminary July S&P Global PMI indices weakened in aggregate, though not as extremely as Europe’s. The manufacturing index rose from 46.3 to 49.0 — an unexpected improvement — but the services index fell from 54.4 to 52.0 — an unexpected deterioration. The composite index fell from 53.2 to 52.0.
Our take: The Fed delivered exactly what the market expected. Now there will be time and ample economic data for the FOMC and the markets to digest before the September meeting. Whether they hike in September, November or neither, a 25bp difference in the terminal rate is relatively inconsequential given all of the cumulative tightening so far. The bigger driver of fixed income performance will be how long rates need to stay high, and how deep the cuts will be once they inevitably begin. We continue to favor a mix of short-term and longer-term positioning, to capture some additional yield in the front end, but also generate capital gains from longer-term bonds when rates eventually go lower.
Corporate Bond Market Commentary
- U.S. High Yield tightened 1 bp last week to an OAS of 389 bp. The index now sits 92 bp tight to YE22. On a total return basis, US HY was flat on the week as modestly positive performance for CCCs (+0.1%) and Bs (+0.1%) was offset by slightly negative performance for BBs. On a YTD basis, US HY is up 6.6% with CCCs (+11.8%) leading Bs (+7%) and BBs (+5.2%).
- HY funds reported a net inflow of $2.2 billion last week.
- US HY primary market activity picked up materially last week with seven issuers pricing ~$3 billion.
- Investment grade spreads tightened 2bp to +126 and yields rose 2bp to 5.52%, resulting in a total return of +0.11%. YTD returns are now +3.7%.
- New issue supply was $30.2 billion, let by financial issuers after earnings reports. Demand was strong as evidenced by new issue concessions of 5.1bp versus the YTD average of 9.4bp. This week should be a little quieter due to the FOMC meeting.
Our take: Markets have taken a breather over the last several days after the strong move and ahead of the FOMC meeting this week. Heavy calendar of earnings releases this week showing mixed performance. We are about to enter the doldrums of August, when trading activity will slow meaningfully. We continue to advocate the up-in-quality positioning ahead of an economic slowdown and think the next 6 weeks may be a coupon clipping environment with more muted volatility.
Municipal Bond Market Commentary
- For the week ending July 21, 2023, high grade tax-exempt municipal bonds yields were 6, 7, 8, and 7 bps lower across the curve at 2,5,10, and 30 years, outperforming US Treasuries by 13, 12, 8 and 4 bps respectively.
- Ratios fell as a result of the relative outperformance, with AAA Muni/Treasury ratios ending the week at 59%, 62%, 64% and 90% at 2, 5, 10 and 30 years. AA Muni/AA Corporate ratios finished the week lower in 2, 5 and 10 years at 60%, 59% and 59%, and slightly higher in 30 years at 79%.
- For the period ending July 19, tax-exempt funds reported inflows of $1.04 billion.
- The new issue muni calendar is $5.88 billion for the week, a little lighter than average but typical for the week of Fed meetings.
Our take: The muni market rallied slightly across the curve even as the US Treasury yields were higher for all but the 30-year. It was a light week in terms of economic data and the markets were already looking forward to this week’s FOMC meeting. The song remains the same in municipal bonds – the technical supply imbalance remains in place as does our near-term outlook for continued richness in the muni market over the summer months, as new issuance is expected to be well short of reinvestment dollars from called and matured bonds. Current visible net supply is -$19.5 billion.
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