Economic Commentary
- Initial jobless claims dipped to 217,000, from 221,000, a bit below the consensus of 220,000. Continuing claims also fell slightly to 1,873,000, from 1,884,000, in line with the consensus. The small dip in initial claims last week suggests that the impact from the hurricanes and the Boeing strike—which ended on November 4—has faded from the numbers.
- October PPI rose 0.196% headline and 0.302% core (ex-food, energy, and trade services), for 2.41% and 3.50% annual increases respectively. While the monthly increases were near consensus, the annual increases were both a tenth higher than expected. When considering modest upward revisions to September, the PPI was slightly hotter than expected, but not high enough to worry about.
- The October CPI came in mostly as expected, rising 0.2% headline and 0.3% core for 2.6% and 3.3% year-on-year increases, respectively. There were pockets of pleasant surprises and areas of concern, like most inflation reports.
- Further parsing the housing components, primary rent rose by 0.30%, slightly below its 0.36% six-month average, but owners’ equivalent rent increased by 0.40%. Together, these two components accounted for a hefty 0.15pp of the increase in the core CPI. The modest rate of increase in Zillow’s measure of new rents—month-to-month increases have averaged just 0.19% over the last six months—points to scope for lower increase in primary rents ahead. Meanwhile, the primary rent-to-OER spread is volatile, but should average close to zero over the second half of this year as a whole.
- With October CPI and PPI in hand, the Fed can say for now that the latest inflation data is cool enough to cut again in December. There is another round of inflation data coming before the meeting next month, however.
Our take: The Fed is committed to being data dependent, and the data is sending mixed signals. Inflation progress has stalled recently, but the core CPI was lifted by components which are either volatile or which the Fed has indicated it would look past. The front end of the yield curve is more sensitive to the timing and amount of rate cuts, while the longer end has been whipsawed by concerns around fiscal policy, deficits, the neutral rate, and term premium. Many of these more theoretical considerations are hard to quantify, and hard to estimate given they will depend on policies which may or may not get enacted and any responding countermeasures. The risk reward at higher yield levels is more balanced and adding some short/intermediate duration makes sense, but waiting for more clarity on fiscal policy is justifiable before adding more long duration bonds.
Corporate Bond Market Commentary
- IG spreads narrowed 9bp to a new recent tight of +77bp and total returns were +1.17%.
- Inflows were $316 million.
- New issuance was only $1.9 billion.
- HY spreads tightened 20bp to +263bp and total returns were +0.78% (BBs +0.71%, Bs +0.88%, CCCs +0.77%).
- Inflows were $622 million.
- There was no HY new issuance.
Our take: Strong market technicals continue to support strong performance in HY bonds. New issuance has been low, dealer inventory was light and got reduced further by a recent $4 billion OWIC by an overseas investor, and fund inflows overall have been favorable. By credit quality, BBs have been hindered by their rate sensitivity, while CCCs have compressed strongly with risk on behavior, m&a activity and other risk-on behavior. The recent significant rise in interest rates will have a disproportionate impact on lower rated companies and their debt-heavy capital structures. With spreads at recent tights, scope for further tightening would appear limited, but if animal spirits keep thriving and defaults are benign, compression could continue. We continue to believe that BBs are attractive, even more so with the recent spike in yields, and lower rated credits need to be carefully underwritten on a case by case basis, which plays into our strengths as fundamental credit investors.
Municipal Bond Market Commentary
- It was a volatile week in fixed income markets, but in the end US Treasury and muni yields fell slightly across all but the short end of the curve for the week ending November 8. AAA muni yields were down 3, 3, 4, and 10 bp at 2, 5, 10 and 30 years while US Treasury yields were up 5 bp at 2 years, and down 3, 8, and 11 bp at 5, 10 and 30 years.
- Muni bonds outperformed Treasuries at 2 years and lagged the rest of the curve, moving AAA Muni/Treasury ratios lower by 2% at 2 years and unchanged elsewhere to end the week at 62%, 65%, 69% and 84%. AA Muni/AA Corporate ratios were down 1% at 2 years, unchanged at 5 and 10 years, and up 1% at 30 years to end the week at 64%, 63%, 66% and 79% at 2, 5, 10 and 30 years.
- For the period ending November 6 municipal bond funds had inflows of $1.26 billion.
- With the election and FOMC in the rear view mirror issuance picks up this week, with $6.4 billion in new issues expected.
Our take: While markets continue to watch economic numbers, especially those related to employment and inflation, expectations and impacts of the coming Trump administration and Republican control of Congress are now added to the calculations. Municipal bond relative value supply/demand technicals have recently pointed to net demand with lower issuance, increased reinvestment dollars, and strong recent fund flows, but projected visible supply increases and elevated dealer inventories are clouding those predictions.
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Shelton Fixed Income Strategies
