Economic Commentary
- Third quarter GDP grew 4.3%, a percentage point faster than the consensus expected. Excluding GDP’s most volatile components and public sector consumption, final sales to private domestic purchasers grew 3% in Q3. Two large contributors were a 6.8% increase in healthcare services spending and an 11.2% increase in services exports, which could be revised downward or reverse in Q4.
- Personal consumption rose 3.5%, ahead of the 2.7% expectation.
- The Core PCE price index rose 2.9%, an increase from 2.6% in the prior quarter.
- Fed minutes from the December meeting show that most officials can see further rate cuts as appropriate IF inflation declines over time. However, some members articulated that they believe rates should remain on hold ‘for some time’. A few of those who went along with the rate cut in December indicated that it was a close call and they could have also supported keeping rates unchanged.
Our take: Recent consumer surveys continue to indicate weaker sentiment among lower- and middle-income households. Job growth through the second and third quarters was close to zero. When the economy is this strong and there is next to no job creation, productivity must be booming, which might allow for cooling inflation with solid growth. This in turn could allow the Fed to cut more than just the 1 cut implied by the dot plots. Potential changes in Fed leadership and committee composition in early 2026 could also add uncertainty to the pace and messaging of policy decisions. We will await to see what happens with Lisa Cook’s lawsuit and whether Jerome Powell chooses to stay on the FOMC when his Chairmanship ends. The FOMC minutes confirm what we already know – the committee is divided, and future economic data will be needed to determine around which direction they will coalesce.
Corporate Bond Market Commentary
- Investment grade bond spreads were 1bp tighter last week to +79bp and total returns were +0.26%. Year-to-date returns are now +7.98%.
- No IG new issues were priced last week.
- Fund flows into investment grade funds were +$2.01 billion last week and +$1.27 billion the week before.
- High yield bond spreads were -4bp tighter to +286bp last week and total returns were +0.19% (BBs +0.17%, Bs +0.17%, CCCs +0.36%). Year-to-date returns are now +8.37%.
- No new HY issues were priced last week.
- Fund flows for HY funds were -$1.08 billion last week and +$1.26 billion the week before. Leveraged loan outflows were -$370.1 million last week and -$1.15 billion the week before.
Our take: The last few weeks brought a respite in both new issuance and secondary market activity ahead of what should be a very active 2026. This pickup should be driven by increasing supply from accelerating M&A activity, and AI-related construction, although the timing and ultimate amounts remain to be seen. Dr. Torsten Slok, the Apollo Chief Economist, estimates that 14% of investment grade issuance in 2025 was by AI-related companies, up from 7% in 2024. We would not be surprised for this to increase further in 2026 which could push spreads wider to induce marginal buyers to participate.
Municipal Bond Market Commentary
- The municipal bond index returned +0.09% last week and is now up +4.16% year to date.
- The new issue calendar this week has $1.32 billion of expected deals. 30-day visible supply is $6.24 billion but should increase after the holidays.
- Fund flows were +$1.513 billion with +$2.07 billion inflows into ETFs and -$557 million outflows from mutual funds.
Our take: Several muni strategists are citing taxable money market yields falling below the symbolic 4% threshold as a possible trigger for some of the $8+ trillion invested in money market funds to start to rotate into high quality duration such as municipal bonds. The muni yield curve is steep by historical standards, which should also continue to attract investors at the longer end of the curve.
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