Economic Commentary
- At the end of this month, funding for the US government expires — if a new spending plan or short-term continuing resolution is not passed by that date, then the government will “shut down” for the first time since 2018.
- S&P Global PMIs were down modestly from last month and slightly below estimates. Manufacturing was 52.0, Services was 53.9 and the Composite was 53.6, down from 53.0, 54.5 and 54.6 last month.
- New home sales increased sharply in August, from 664k to 800k, up 20.5% month over month and well above expectations of 650k.
- GDP for Q2 was revised from 3.3% up to 3.8%, largely caused by upward revisions to services consumption from 1.2% to 2.6% and to business fixed investment from 5.7% up to 7.3%.
- The GDP price index was 2.1%, slightly above the 2.0% for both last quarter and this quarter’s expectation. The Core PCE price index was 2.6%.
- Durable goods orders were +2.9% and excluding transportation were +0.4%.
- Initial jobless claims were 218k, down from a revised 232k last week and below the 233k estimate. Continuing claims were 1926k, down from a revised 1928k and below expectations of 1932k.
Our take: The economic data released this week suggests that the economy is not falling off a cliff. The consumer-spending driven upward revision to GDP could be that the consumer is confident and spending, or it could be the recovery from the uncertainty pause in the Spring causing a temporary boost. More important to the near-term path of interest rates, the labor market is not crumbling, yet. The probability of a rate cut at the October meeting decreased from 93% yesterday to 83% today after the data was released. The next FOMC meeting is not until October 29th, allowing ample opportunity for further twists and turns caused by economic data, fiscal policy, court decisions, and a potential government shutdown.
Corporate Bond Market Commentary
- IG spreads were 3bp tighter to +74bp, the tightest since 1998, and total returns were -0.10%.
- New issue supply was $34.5 billion as NICs were 2.1bp, books were 4.9x covered, attrition was 17%, and spreads tightened 30bp on average from IPT to final pricing.
- IG fund flows were +$3.7 billion, the lowest in 8 weeks.
- HY spreads tightened 7bp to +272bp and total returns were +0.31% (BBs +0.22%, Bs +0.35%, CCCs +0.66%).
- HY new issue supply was $11.5 billion, including deals from American Axle, DirecTV, Tronox, Diversified Healthcare Trust, Melco Resorts, Kodiak Gas and others.
- HY fund flows were +$940 million.
Our take: The investment grade bond market tightened to spreads not seen in 27 years. However, it is crucial to understand that the composition of the IG market is arguably worse than it was in 1998 in terms of the composition of BBBs, lower all-in yields, higher financial leverage of the underlying companies, and the sheer size of the overall market. Therefore, risk adjusted spreads could look worse. These spreads and all-in yields are being justified by potential future rate cuts, ample liquidity in the overall system, wide open capital markets, animal spirits, relative value compared to equities and others. While we can continue to identify individual bonds that are compelling on a relative and absolute value basis, we also maintain a hedge in the form of the CDX IG Index, which we believe is a very compelling one given its very low cost of carry and asymmetric potential return profile.
Municipal Bond Market Commentary
- The municipal bond index returned +0.26% last week.
- Yields were unchanged, -1bp, -2bp, and -1bp and ratios were +1, -1, -2, and -2 to finish at 57%, 57%, 68%, and 88% at 1, 5, 10, and 30 years respectively.
- Fund flows were +$1.117 billion, with $243 million into mutual funds and $874 million into ETFs.
- Last week’s new issuance was $8.4 billion, and this week’s new issue calendar totals $15.2 billion.
Our take: Typically, the fall season brings a headwind of additional supply and less reinvestment dollars from called or maturing bonds. However, this fall these technical factors coincides with the resumption of a Fed rate cut cycle. October net supply could be more than $41 billion, which would be the largest monthly total since 2017. For those investors who buy individual bonds, perusing the new issue calendar over the coming weeks, especially if a wave of supply indeed comes, could provide good opportunities to find value amidst the new issue concessions that might be required. For those investors who buy funds or ETFs, this potential wave of supply could also cheapen-up the overall market, providing an attractive opportunity to initiate or add to positions.
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