Weekly Fixed Income Commentary: Accelerating coronavirus cases suppress Treasury yields
Highlights
- Credit sectors enjoyed strong performance, led by investment grade corporates.
- Municipal yields declined, and we expect the good tone to continue.
- The global aggregate index delivered a solidly positive total return in excess of U.S. markets.
U.S. Treasury yields closed lower last week, led by longer maturities. Despite positive news on possible vaccine progress, investors were focused on the potential near-term damage from surging virus cases across the globe. A public dispute between the U.S. Treasury and the Federal Reserve (Fed) about the Fed’s lending facilities also undermined investor confidence.
COVID-19 case spike pulls Treasury yields down
All U.S. Treasury yields closed lower last week, led by longer maturities. Rates fell and the yield curve flattened, as accelerating coronavirus cases stoked concerns about potential lockdown measures. While additional positive vaccine news early in the week improved the longer-term economic outlook, investors were more focused on potential near-term damage from surging virus cases across the globe. Economic data showed continued strength in the housing market, but also a surprising drop in U.S. retail sales. Weakening U.S. growth and diminished hopes of additional fiscal stimulus have fueled speculation that the Fed may need to adjust its bond buying program at its December meeting to purchase more long-maturity issues. The week ended with a soft risk tone, as a public dispute between the Treasury and the Fed about the central bank’s lending facilities undermined investor confidence.
Non-Treasury sectors fared well last week, despite a cautious risk tone, and all sectors posted positive total returns. The credit sectors enjoyed the strongest performance, led by investment grade corporates. Taxable municipals, preferred securities and high yield corporates followed suit with total returns surpassing Treasuries. Duration drove returns for the week, as the longest components of the aggregate index enjoyed returns above 2%, while the shortest assets were up less than 10 basis points (bps). The securitized sectors posted the lowest weekly returns, with asset-backed, mortgage-backed and commercial mortgage-backed securities all experiencing only modest positive total returns. The global aggregate index delivered a solidly positive total return ahead of U.S. markets, as Asian and European markets produced similarly strong returns.
Duration drove taxable returns, as the longest components of the aggregate index enjoyed returns above 2%.
Municipal reinvestment demand remains heavy
Municipal yields declined last week. The new issue calendar returned to outsized supply at $11.4 billion and was well received. Fund flows were positive at $1.3 billion. This week’s new issue supply should be muted at $2.1 billion due to the Thanksgiving holiday.
The municipal market has a very good tone, which we expect to continue. The Fed has signaled that rates will stay lower for longer, at least until the U.S. recovers from the pandemic. Municipal new issue supply was muted just prior to the election, and this trend should occur again during Thanksgiving week. Reinvestment demand is heavy, with December and January bringing outsized reinvestment coupons.
The state of New Jersey issued $3.7 billion general obligation coronavirus emergency bonds (rated A3/BBB+). The deal was heavily oversubscribed, with all maturities trading 20 bps richer in the secondary market. Yet the deal was priced to sell. For example, the 10-year bonds were issued at a yield of 2.08%, more than 100 bps of additional yield to the MMD tax-exempt AAA curve.
High yield municipals are performing well in November. Fund flows are dominantly positive, credit spreads are contracting at an accelerating rate and year-to-date performance is recovering. Supply should be minimal in a holiday-shortened week. Fund flows will likely continue to climb, setting up the market to perform when supply is better able to respond to demand. In Puerto Rico, the Oversight Board has given authority to resume mediation with general obligation creditors, and allowed filing a plan of adjustment should those negotiations fail.
Investment grade corporates outperform on robust demand for longer-dated debt
Investment grade corporate bonds were last week’s top performer, benefiting from their longer duration as rates fell and the Treasury curve flattened. The average investment grade yield closed the week at 1.85%, within a few basis points of its all-time low. Fund inflows totaled $4.6 billion, the most in four weeks. In the primary market, 32 issuers priced $38 billion in new supply. The tone soured late in the week after the U.S. Treasury Department unexpectedly asked the Fed to end its pandemic-related emergency lending programs.
High yield corporates produced gains for the third week in a row. Lower-quality credits and previously lagging sectors like transportation and energy led the way. Overall spreads tightened by 13 bps, and fund flows were modestly positive at $490 million. The average yield on high yield credit, which hit an all-time low of 4.57% two weeks ago on the heels of the Pfizer vaccine announcement, continued to hover in historically low territory.
The average yield on high yield corporate credit continued to hover in historically low territory.
Emerging markets (EM) debt finished near the middle of the pack, bolstered by positive news on the vaccine front but tempered by caution amid surging COVID-19 cases and related shutdowns. Strong new-issue supply met healthy demand, evident in another week of increased flows into EM funds. Local-currency debt bested U.S. dollar-denominated issues. The Turkish lira and Brazilian real have fared especially well against the dollar.
In focus: Treasury asks to end emergency lending facilities
Despite some alarm-inducing headlines surrounding a premature end to the Municipal Liquidity Facility (MLF), Secondary Market Corporate Credit Facility (SMCCF) and Term Asset-Backed Securities Loan Facility (TALF), we expect limited market impact. Overall liquidity remains strong, issuers have access to other funding sources and any possible interruptions in the program may turn out to be short-lived.
Use of the MLF and TALF has been limited, as most issuers found it more economical to access funding from the traditional cash market and/or direct borrowing from banks. The end of the SMCCF program could be a modest negative for investment grade corporates since it removes a backstop against market instability. But the spread impact has been minimal.
Municipal fund flows are strong, issuance remains high and we see strong demand for new issues across the credit spectrum.
AAA and TALF-eligible ABS spreads have narrowed meaningfully since March and that segment is functioning well. Non-AAA, non-index-eligible ABS remain quite dislocated, and we view this market segment to be quite attractive relative to similarly rated corporate debt with significantly longer durations and tighter spreads.
Likewise, improving corporate fundamentals and strong technicals should support spread compression in investment grade corporates.
Performance:Bloomberg L.P.
Issuance: The Bond Buyer, 20 Nov 2020.
Fund flows: Lipper.
New deals: Market Insight, MMA Research, 18 Nov 2020.
Any reference to credit ratings refers to the highest rating given by one of the following national rating agencies: S&P, Moody’s or Fitch. Credit ratings are subject to change. AAA, AA, A and BBB are investment grade ratings; BB, B, CCC, CC, C and D are below-investment grade ratings.
Representative indexes: municipal: Bloomberg Barclays Municipal Index; high yield municipal: Bloomberg Barclays High Yield Municipal Index; short duration high yield municipal: S&P Short Duration Municipal Yield Index; taxable municipal: Bloomberg Barclays Taxable Municipal Bond Index; U.S. aggregate bond: Bloomberg Barclays U.S. Aggregate Bond Index; U.S. Treasury: Bloomberg Barclays U.S. Treasury Index; U.S. government related: Bloomberg Barclays U.S. Government-Related Index; U.S. corporate investment grade: Bloomberg Barclays U.S. Corporate Index; U.S. mortgage-backed securities; Bloomberg Barclays U.S. Mortgage-Backed Securities Index; U.S. commercial mortgage-backed securities: Bloomberg Barclays CMBS ERISA-Eligible Index; U.S. asset-backed securities: Bloomberg Barclays Asset-Backed Securities Index; preferred securities: ICE BofA U.S. All Capital Securities Index; high yield 2% issuer capped: Bloomberg Barclays High Yield 2% Issuer Capped Index; senior loans: Credit Suisse Leveraged Loan Index; global emerging markets: Bloomberg Barclays Emerging Market USD Aggregate Index; global aggregate: Bloomberg Barclays Global Aggregate Unhedged Index.
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