Economic Commentary
- The dominant story of the week has been geopolitical escalation involving the U.S., Israel, and Iran, with markets reacting through higher oil prices and rising bond yields.
- The Fed Beige Book surveying the few weeks prior to February 23 reported that, “on balance, firms expected prices to rise at a somewhat slower pace in the near term.”
- ADP reported private sector payrolls grew 62k in February, close to the 50k consensus. Interestingly, 60k jobs were created by small employers, who had not been meaningful contributors recently.
- The ISM manufacturing index fell slightly from 52.6 to 52.4. The prices-paid component spiked from 59.0 in January to 70.5, suggesting price increases accelerated last month at the fastest pace since the summer of 2022. All commodities listed except freight were up in price, including a 27th straight month for aluminum. The featured survey respondents place the blame on tariffs, with specific focus on section 232’s effects on aluminum and steel.
- The ISM Services index rose from 53.8 to 56.1, its highest since 2022. The rise of services was fueled by strong business activity and strong new orders. The combination suggests a strong rebound in Q1 from the economic slowdown caused by the government shutdown in Q4. However, the Services prices-paid component did not echo the Manufacturing survey’s suggestion of accelerating production costs.
Our take: Risk markets may take direction from signals regarding how long the conflict involving Iran persists and when supply disruptions in energy markets may abate. The good news is that there are new pipelines for producers to partially circumvent potential Hormuz bottlenecks, the U.S. is a net oil exporter in 2026, and U.S. shale producers can provide swing capacity to help offset global supply issues. An energy price spike typically causes a temporary increase in headline inflation that passes only partially through into core inflation. The Fed appears reluctant to cut rates, possibly reflecting confidence in future rather than realized disinflation. As a result, the market has pushed out expectations for the next rate cut marginally farther. Fed funds futures suggest the market is largely expecting the next rate cut at the September FOMC after pricing in the July meeting as recently as Friday. Importantly, the market continues to anticipate a fed funds rate near 3% by late next year.
Corporate Bond Market Commentary
- Investment grade bond spreads widened 7bp last week to +85bp and total returns were +0.20%.
- IG issuance was $63.6 billion last week, including large deals from Abbott Labs and Abbvie. Order books were 4.0x covered, NICs were 4.2bp, attrition was 25% and deals were tightened 28bp on average from IPT to final pricing.
- IG fund flows were +$1.8 billion.
- High yield bond spreads widened 24bp to +310bp and total returns were – .31% (BBs -0.15%, Bs -0.34%, CCCs -1.14%).
- HY new issuance was $7 billion including deals from Chemours, Sunoco, Matador Resources, SiriusXM, Ryman, Pitney Bowes, Wyndham, and Wesco.
- HY fund flows were -$406 million, and loan funds saw an elevated -$1.5 billion outflow.
Our take: Credit markets are in risk-off mode this week on the back of the conflict in Iran, which has pushed energy prices higher and taken bond yields higher due to rising inflation expectations. Markets were already vulnerable given increasing concerns about private credit, the uncertain returns on the massive investments in AI, and the potential negative impact of AI on software and other sectors. The high yield market held up reasonably well initially, given that it is over 50% BB-weighted and has a duration below 3. But as the risk-off mentality persists, cracks are becoming more pervasive. This volatility may beget interesting opportunities for investors to add quality names at a better price.
Municipal Bond Market Commentary
- The municipal bond index returned +0.41% last week.
- Yields were -3, -2, -2, and -4 and ratios were unchanged, +2%, +1% and +1% to 58%, 59%, 62% and 87% at 1, 5, 10, and 30 years respectively.
- Fund flows were +$1.04 billion including $381 million into mutual funds and $659 million into ETFs.
- Last week’s new issue volume was $10.6 billion. This week’s calendar is $12.1 billion, of which $11.1 billion is tax-exempt.
- February new issue volume was $43 billion, up 12% versus last year.
Our take: Municipal bond net supply year to date is $24 billion, which has been easily digested, aided by $19 billion of fund inflows. March and April net supply is estimated to be $25 billion and $37 billion, respectively, which may present a greater supply challenge. If the recent rise in UST yields on the back of the rise in oil continues, it could make the digestion problem more acute and may lead to lower municipal bond valuations in the weeks ahead.
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