Economic Commentary
- As expected, the Federal Reserve left rates as-is, the post-meeting FOMC statement was little changed, and forward guidance maintained the same hawkish tone it has for the last two meetings.
- The updated Summary of Economic Projections (dot plots) skewed even more hawkish: the 2024 and 2025 median dots were revised both revised higher by 50bp, supported by stronger growth outturns and inflation projections remaining above target through 2026. However, Core PCE is projected to end 2023 at 3.7% instead of 3.9% in June.
- The worry is simmering throughout bond markets, with the 10-year Treasury yield reaching 4.49%, the highest since November 2007.
- University of Michigan sentiment indicators are rolling over, but 1 year and 5–10-year inflation expectations remain very well anchored.
Our take: Our take: As they should be doing at this point in their rate hiking cycle, the Fed continues to talk tough and push rates higher for longer. They need to maintain this hawkish posture until it is painfully evident that inflation is well on its way to their 2% goal. Unfortunately, at that point the damage will have been done and the economy will be slowing rapidly, likely forcing the market to re-accelerate forward the timing of expected rate cuts. For now, though, with only two rate cuts projected in 2024, the Fed is implying a soft landing. We think that the likelihood of achieving this with a soft landing seems improbable and would fly in the face of historical precedent; however, the Treasury yields have risen since the release.
Corporate Bond Market Commentary
- U.S. High Yield tightened 6 bp last week to an OAS of +379 bp. On a total return basis, US HY rose 0.2% reflecting outperformance for CCCs (+0.6%) versus Bs (+0.3%) and BBs (flat).
- HY funds reported a modest net inflow of $81 million last week.
- US HY primary markets were very active last week with almost $10 billion of total volume.
- IG spreads widened 1bp to +122bp and total returns were -0.33%. Companies priced over $34 billion of new issue supply, versus initial expectations of $25 billion, bringing month-to-date issuance to $89 billion. IG funds posted a modest inflow of $223 million.
Our Take: US HY bonds have posted losses in seven of the last 13 sessions, reversing a summer rally and sending yields to a more than three-week high of 8.60%. The September downturn comes as borrowers inundate the market with almost $13 billion in new supply, the busiest month since May. With rates pushing higher again and equities rolling over, the HY market will struggle, and we may finally see CCC’s crack. Until rates stabilize and new issue slows down, there is no reason to catch a falling knife as of yet.
Municipal Bond Market Commentary
- For the week ending September 15, 2023, high grade tax-exempt municipal bonds yields were 0, 2, 5, and 2 bps higher at 2, 5, 10, and 30 years, outperforming US Treasuries by 5, 1, 4, and 6 bps at 2, 5, 10 and 30 years.
- AAA Muni/Treasury ratios fell 1% in the 2 and 30 year and were unchanged at 5 and 10 years, ending the week at 63%, 66%, 68% and 90%. AA Muni/AA Corporate ratios were flat at 2 and 5 years, and down 1% at 10 and 30 years to end the week at 63%, 63%, 63% and 81% respectively.
- For the period ending September 13, municipal bond funds reported outflows of $199 million, with ETFs seeing inflows of $1 billion and open-end fund outflows of $1.2 billion.
- The new issue muni calendar is estimated to be $4.9 billion, which is slightly above average for the week of a Fed FOMC meeting.
Our take: AAA Muni/Treasury ratios will likely trend higher over the coming months as fall seasonal new issue supply is expected to exceed reinvestment of called and maturing securities. There is no change to our view that overall direction of the muni market will be largely dependent on changes in the US Treasury curve as the Fed tries to navigate the economy to the 2% target inflation rate without throwing the economy into recession.
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