Economic Commentary
- August nonfarm payrolls rose 162k. The two-month revision was +55k, which was also the consensus forecast.
- Average hourly earnings rose 0.3%, as expected, taking the year-on-year rate down from 3.2% to 3.1%.
- Unit labor costs rose 1.2%, down from 1.3% last month and below the 1.3% consensus estimate.
- August PPI rose 0.4% headline and 0.3% excluding food, energy, and trade services, both in line with expectations. Energy made the biggest contribution to the PPI increase. Year-over-year PPI inflation accelerated from 4.8% (revised from 4.7%) to 5.4%. Year-over-year core PPI inflation was unchanged at 4.7%.
- Treasury announced it would buy a maximum of $6 billion in 10–20-year US Treasuries, but then only ended up repurchasing $5.19 billion.
- The NFIB small-business optimism index fell from 99.8 to 98.7.
- The ISM services index rose more than a point from 54.1 to 55.4. With the exception of February, which was a few tenths higher, August’s index was the highest in four years. The increase was primarily spurred by growth in business activity and new orders.
our Take
Interest rates continue their steady upward climb, as the fundamentals of higher energy prices and fiscal concerns combine with the technicals of rising supply, especially of longer dated investment grade corporates. Markets are now pricing in a 71% probability of a hike at next week’s FOMC meeting, and 3.35 hikes in total by next year. We aren’t sure exactly what will turn sentiment around, and it may not happen imminently, but these all-in yields haven’t been seen for a long time, and history suggests that bond market vigilante behavior abates when markets move on to focusing on something else.
Corporate Bond Market Commentary
- Investment grade spreads were 2bp wider to +81bp, and total returns were -0.27%. YTD returns are -0.31% and are negative for all but BBBs (+0.07%).
- IG new issuance was $9.3 billion last week. New issue concessions were 3.5bp, books were 3.8x covered, attrition was 21% and deals were tightened 27bp on average from initial price talk to final pricing.
- Week-to-date issuance is $73.2 billion so far.
- IG fund flows were +$1.8 billion
- High yield bond spreads were 8bp wider to +268bp and total returns were -0.15% (BBs -0.15%, Bs -0.17%, CCCs -0.11%).
- There was no HY new issuance last week. This week has seen a handful of new deals, but not as quick of a recovery as the IG market.
- HY fund flows were -$49.5 million and leveraged loan inflows were +$990 million.
Our Take
Single-B bonds have led the high-yield market year to date, returning 3.49%, compared with 2.42% for BBs and 0.03% for CCCs. We have maintained an emphasis on the single-B segment for much of the year, as current economic conditions have remained supportive of this level of credit exposure while its shorter duration can reduce sensitivity to changes in interest rates relative to higher-quality segments. Single-B bonds currently offer a 7.38% yield with a duration of approximately 2.8 years.
Municipal Bond Market Commentary
- The municipal bond index returned -0.69% last week, underperforming USTs and IG corporate bonds.
- Muni yields were +8bp, +10bp, +14bp, and +12bp, and ratios were +2%, +1%, +2%, and +2% to 60%, 65%, 72%, and 89% at 1, 5, 10, and 30 years respectively.
- Last week’s new issue calendar was $17 billion, and this week’s calendar totals $18.1 billion, of which $17 billion is tax-exempt.
- Muni fund flows were +$1.367 billion, including $170 million into mutual funds and $1.197 billion into ETFs.
Our Take
The sharp rise in muni yields is pushing levels towards interesting entry points. The crossover tax rate is now 40% at 1 year, 35% at 5 years, 28% at 10 years, and 11% at 30 years. In addition, we are approaching levels where the corporate versus muni crossover window starts to open. With ratios at 10 and 30 years at their 90-day highs, and 5-year municipals at 2.94% yield and a 65% ratio, these are all relative value signals that typically start to attract investors. With the large calendar expected to continue, yields could remain under pressure, but current levels warrant a closer look for investors evaluating opportunities to add municipal exposure.
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