Economic Commentary
- The Fed left rates unchanged and moved from a hiking cycle to a neutral stance. Chairman Powell pushed back against a March first rate cut, as the FOMC is looking for more certainty that they are well on their way to their 2% inflation goal.
- The Treasury Refunding announcement of $760 billion for the January to March period is $55 billion lower than Treasury’s $816 billion estimate announced at the end of October. Treasury cited a higher-than-expected cash balance in the Treasury General Account at the end of the last borrowing period and “projections of higher net fiscal flows.” The borrowing needs for April-June are estimated to fall to $202 billion, though that number includes a high degree of uncertainty considering legislation in the pipeline that could widen the deficit.
- Q4 productivity rose at a 3.2% rate, above the consensus, 2.5%. Unit labor costs rose at a 0.5% rate, below the consensus, 1.6%.
- Initial jobless claims rose to 224K from 215K, above the consensus, 212K.
Our take: Several good data points on the labor markets – higher productivity, lower unit labor costs, and a lower employment cost index – suggest that this crucial component of services inflation is continuing to moderate, and that inflation has already reached the target on a run-rate basis. Meanwhile, growth continues to run hot with the Atlanta Fed GDPNow Index rising to +4.2%. The Fed is waiting too long to cut rates, and risks overcorrecting. This will produce volatility and potentially a harder landing than the prevailing goldilocks soft landing sentiment. Rates should continue to grind lower overall, with volatility along the way.
Corporate Bond Market Commentary
- High yield spreads were 15bp tighter, driving total returns of +0.64%. Single Bs (+0.76%) outperformed CCCs (+0.72%) and more rate sensitive BBs (+0.52%).
- Fund flows were +$430 million.
- HY new issue supply of $7 billion pushed month to date over $22 billion. The composition continues to be heavily weighted towards lower quality issuers who take capital when markets are wide open, rather than higher quality borrowers who are likely waiting for even lower all-in rates.
- IG spreads tightened 4bp to +97bp, pushing weekly total returns to +0.23%.
- The IG primary market priced $18.6 billion of new issues, somewhat below estimates of $25 billion. Order books were strong at 4.4x oversubscribed and new issue concessions were 0.
- Fund flows into IG were $1.043 billion.
Our take: The tsunami of IG issuance has slowed modestly, and overall IG returns have been underwhelming, as higher rates offsetting spread tightening have flipped to lower rates but leaking spreads. That said, the IG market’s ability to handle all of this supply, and its resiliency in an economic slowdown should offer reasonably good performance going forward, but the already tight spreads limit outsized return probabilities. HY bond supply is ramping up after a slower start to the year, and the new issue performance has been strong as elevated cash balances need to be put to work. We fully expect hiccups along the way in rates, spreads, earnings and economic data, which will offer fertile ground for opportunistic and tactical trading opportunities in 2024.
Municipal Bond Market Commentary
- For the week ending January 26, high grade tax-exempt municipal bond yields rose 2, 2, 3 and 6 bps at 2, 5, 10 and 30 years, underperforming US Treasuries across the curve with US Treasury yields falling by 4 and 1 bps at 2 and 5 years and rising by 1 and 4 bps at 10 and 30 years.
- AAA Muni/Treasury ratios were 1% higher at all but the 30 year where they remained steady, ending the week at 65%, 62%, 62% and 84%. AA Muni/AA Corporate ratios were 1% lower at 2 and 5 years and steady at 10 and 30 years, to end the week at 63%, 59%, 57% and 78% respectively.
- For the period ending January 24, municipal bond funds reported inflows of $211 million, with $534 million into open-end funds and $323 million of outflows from ETFs.
- The muni new issue calendar is expected to be about $4.55 billion this week, lighter than normal due to the FOMC meeting.
Our take: The muni markets continued to follow the UST markets as we navigated a busy week with the FOMC, nonfarm payrolls, and unemployment numbers. Municipal bond yields remain at high nominal levels relative to the last decade, but they remain historically rich to US Treasuries and IG corporates. Recent fund inflows and reinvestment capital have offset elevated supply thus far in 2024 to maintain the low AAA muni/Treasury ratios. We expect stronger new issuance in 2024 and would expect ratios to rise unless offset by fund inflows. That said, it is possible that municipal fund performance in 2023 may entice retail buyers and provide the fund flows needed to support continued richness in municipal bonds.
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