Weekly Fixed Income Commentary (December 15, 2023)
Economic Commentary
- The FOMC left rates unchanged at their last meeting of 2023. More importantly, they gave their strongest indication yet that their pause is in fact the end of the rate hike cycle, and did not take the opportunity to push back on the massive move lower in rates and easing of financial conditions.
- Producer prices continued to cool in November, boosting confidence that the worst consumer price inflation is in the past. The headline producer price index was pulled lower by declining energy prices, but the “core” series excluding food, energy, and trade services, also slowed. Year-on-year increases in the core index improved from early-2022 peaks before plateauing in May of this year around 3%. With Including November data, the annual increase was 2.5%, the lowest since February 2021.
- The November CPI rose 0.1%, above the consensus forecast of no change, for an as-expected 3.1% year-on-year increase. The core CPI (excluding food and energy) rose 0.3%, in line with the consensus, for a 4.0%, also expected, year-on-year increase. In October, headline year-on-year inflation was 3.2% while the core was also 4%.
- November retail sales came in above expectations, which isn’t overly surprising given the large decrease in gasoline prices and moderating inflation in other areas, freeing-up some dollars for consumers to spend. However, October retail sales were revised lower.
Our take: The spectacular rally in bonds found another gear over the last week, turbo-charged by what was effectively an ‘all clear’ signal from the Federal Reserve. This sign that it’s safe to go back in the water should propel massive fund flows into bonds. Much of this rotation will come from cash or T-bills; this is the once-in-a-cycle opportunity we have been banging the table about – if you stayed in cash, you’ve just learned a difficult lesson on opportunity cost. As this tsunami of money flows in, bonds will need to be bought, which will propel existing bond prices higher.
Corporate Bond Market Commentary
- S. High Yield tightened 12 bp last week to an OAS of 375 bp. On a total return basis, US HY climbed +0.3% on outperformance from CCCs (+0.7%) versus Bs (+0.3%) and BBs (+0.2%).
- HY funds saw $1.9 billion of inflows.
- US HY primary market activity was robust last week with 14 issuers pricing over $8 billion of new notes. This came on the heels of almost $20 billion of total volume in November.
- Investment grade spreads tightened 1bp to +110bp. Total returns were +0.28%.
- IG New issue supply was $20.4 billion and fund flows were -$2.2 billion.
Our take: Last week’s modest returns accelerated this week as interest rates moved lower and investors who were on the sidelines started to get back in the water, adding spread tightening on top of the rate move to produce a more significant rally. All of the forecasts for 2024 are now obsolete, and some of those juicy returns in 2024 have surely been pulled forward into this current Q4 of 2023. From here forward, rates will go lower, and coupon carry will also add to returns. However, some of the easy gains have been made, and being tactical to trade around rallies & pullbacks in the market and to pounce on the inevitable dispersion and single-name volatility caused by the slowing economy will be paramount in generating incremental returns in the coming year.
Municipal Bond Market Commentary
- For the week ending December 8, high grade tax-exempt municipal bonds yields continued to rally, falling 9, 10, 10 and 8 bps at 2, 5, 10 and 30 years, outperforming US Treasuries with US Treasury yields rising by 18, 12, and 3 bp at 2, 5, and 10 years with the 30 year yield falling by 8 bps.
- AAA Muni/Treasury ratios continued to richen, falling 3-4 percent at 2, 5, and 10 years and staying steady at 30 years, ending the week at 58%, 58%, 60% and 85%. AA Muni/AA Corporate ratios also richened, falling 1-2 percent across the curve to end the week at 58%, 57%, 58% and 78% respectively.
- For the period ending December 6, municipal bond mutual funds reported outflows of $139 million and muni ETFs reported outflows of $5 million.
- The new issue muni calendar was expected to be $4.7 billion, lighter than normal due to the mid-week FOMC meeting.
Our take: Muni ratios have continued to richen in recent weeks, supported by the negative net visible supply of -$15.7 billion on the visible calendar per Bloomberg on 12/8/23. The muni market rallied with the US Treasury market post FOMC but slightly underperformed. This wasn’t a surprise as it is likely that the rich ratios rebound and municipals underperform US Treasuries in the short term unless the muni market draws increased support from fund inflows.
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