Weekly Fixed Income Commentary: Coronavirus continues to fuel dramatic market volatility
- Preferred securities, senior loans and high yield corporates suffered total returns below -10%.
- Municipal yields were cheaper by at least 100 basis points across the curve.
- Emerging markets debt suffered its worst week since the depths of the financial crisis.
The global risk-off sentiment accelerated last week. Treasury yields ended lower, led by 5-year maturities. There was no place to hide, as all non-Treasury sectors endured negative weekly returns. Market dislocation in virtually all asset classes is due to liquidity constraints rather than fundamental credit issues. The Federal Reserve (Fed) announced additional emergency measures, and the federal government has pledged additional fiscal stimulus.
Treasury yields end lower in incredibly volatile week
Last week’s tumultuous markets closed with Treasury yields lower, led by 5-year maturities.1 Short maturities fell sharply in response to Fed actions aimed at improving market liquidity.1 The generic 3-month T-bill yield turned negative for the first time since 2015.1 Generally, surging demand for high quality assets supported Treasury prices, driving yields lower and damaging higher risk non-Treasury sectors.1 However, there were bouts of rising rates as investors sold off liquid assets, with long maturity Treasury yields increasing more than 45 basis points (bps) in two days.
The yield increases were not fueled by improving risk sentiment or economic growth expectations. Rather, they appeared to be driven more by rising supply concerns, as the U.S. deficit is expected to increase due to funding fiscal stimulus measures. Liquidity continued to be challenged and volatility increased. The 10-year Treasury yield closing range exceeded 47 bps, and the intraday trading range was even larger.1
All non-Treasury sectors endured negative weekly returns and dramatically underperformed similar-duration Treasuries.1 Preferred securities, senior loans and high yield corporates suffered total returns below -10%.1 Mortgage-backed securities (MBS) fared best, supported by the Fed’s announcement to begin purchasing MBS once again. Investor selling hit both higher quality and higher risk assets, as investors scrambled to raise cash for immediate spending needs.
The Fed announced additional emergency measures aimed at improving fixed income market functioning, specifically focused on short-term funding markets.
Municipal fund flows were negative, at a record -$12.2 billion.
Municipal new issuance dries up
Municipal bonds sold off dramatically last week, as the Treasury market rallied.1 Municipal yields were cheaper by at least 100 bps across the curve by week’s end.1 Conversely, 10- and 30- year U.S. Treasuries ended the week 30 and 36 bps richer, respectively.1
Buyers had little interest in the new issue market, and most deals were pulled.2 Weekly fund flows were negative, at a record -$12.2 billion.3 This week’s new issuance is scheduled to only be $2.5 billion, and we expect most deals to be withdrawn again.2
Liquidity is challenged in all non-Treasury asset classes, including municipals. The Fed addressed this issue by lowering short-term rates to zero and pledging to buy $700 billion of government securities. This amount will likely increase, and could grow to include corporate and municipal bonds. The federal government has also pledged a fiscal stimulus program of at least $2 trillion to keep the economy going.
Markets may begin to recover once we have evidence of “flattening the curve” of the virus. Until then, liquidity will be challenged and markets will rely partially on government purchasing programs and government fiscal programs to maintain orderly activity.
High yield municipal bond yields stand at 6.12%, on average, rising 135 bps last week and 278 bps over the last two weeks.1 A rush for liquidity has pushed liquidity risk premiums higher than 2008. Investors redeemed $7 billion from high yield municipal bond funds over the last two weeks, greatly eclipsing the financial crisis.3 Crossover buyers have increasingly come into the market, but outflows are overwhelming the ability to produce adequate liquidity.
It’s too early to determine the municipal credit impacts of a prolonged economic shutdown. Ratings downgrades are far more likely than widespread defaults, as many projects and issuers should have meaningful reserves. Sectors most likely to be impacted include convention centers, airlines, airports, ports and senior living.
Historic downturn in credit markets continues
Investment grade corporate bonds accelerated their decline, losing nearly 9% on the week.1Spreads widened by 147 bps amid huge outflows, short-term funding pressures and slumping oil prices, which closed the week below $20 per barrel.1,3 Secondary trading volume was above average despite logistical challenges (e.g., alternate work locations and separated trading desks) posed by the coronavirus. The primary market was extremely busy, with $63.5 billion of new supply from 23 issuers.2
High yield corporates lost more than -10% last week as spreads widened to well over 1,000 bps – more than 650 bps above their levels on 21 February, when the current selloff began.1 High yield performance has begun to decouple from the equity market, which has experienced some occasional (albeit short-lived) bounces off recent lows, while high yield bond prices have steadily declined. Last week’s high yield outflows totaled $2.9 billion, a more moderate pace compared to the previous three weeks.3 Lower-quality (CCC rated) credits again lagged their better-rated (B and BB) counterparts.
High yield performance has begun to decouple from the equity market.
Emerging markets (EM) debt losses deepened as the asset class suffered its worst week since the depths of the financial crisis.1 Liquidity dried up, spreads gapped 176 bps wider and EM fund outflows totaled $4.6 billion.1,3 The twin cudgels of the coronavirus outbreak and the Russian/Saudi oil price war continued to pummel sovereign, corporate and local-currency markets.
In focus: Fed reopens its crisis playbook
Slashing interest rates to zero and launching $700 billion of quantitative easing were just the start of the Fed’s massive policy response to the coronavirus outbreak. Last week, the Fed reached further into its arsenal, reviving several programs from the financial crisis to increase market liquidity in targeted areas.
Through the CPFF (Commercial Paper Funding Facility), the Fed can buy commercial paper – short-term debt issued by nonfinancial companies to pay everyday expenses such as rent or payrolls. The CPFF will also ease pressure on money market funds, many of which were selling their commercial paper holdings to meet redemptions.
The PDCF (Primary Dealer Credit Facility) will provide loans to primary dealers (firms that can purchase U.S. Treasuries at auction), collateralized by a variety of investment grade debt. The PDCF enables dealers to support efficient market functioning and facilitate credit availability to businesses and households.
To keep money markets operating smoothly, the Fed’s MMLF (Money Market Mutual Fund Liquidity Facility) will offer capital to support short-term securities held by money market funds, and to seek to prevent any money market fund’s NAV from falling below $1.
Eventually, the Fed might explore partnering with the U.S. Treasury to guarantee small business loans or backstop the municipal and corporate markets – steps that could require acts of Congress.
1 Bloomberg L.P
2 The Bond Buyer, 20 Mar 2020.
3 Lipper Fund Flows.
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.
Bloomberg Barclays Municipal Index covers the USD-denominated tax-exempt bond market. Bloomberg Barclays High Yield Municipal Index covers the USD-denominated, below investment grade tax-exempt bond market. S&P Short Duration Municipal Yield Index tracks the municipal bond market with maturities from 1 to 12 years. Bloomberg Barclays Taxable Municipal Bond Index is a rules-based, market-value-weighted index engineered for the long-term taxable bond market. Bloomberg Barclays U.S. Aggregate Bond Index covers the U.S. investment grade fixed rate bond market. Bloomberg Barclays U.S. Treasury Index includes public obligations of the U.S. Treasury. Bloomberg Barclays U.S. Government-Related Index includes debt guaranteed, owned and sponsored by the U.S. government; it does not include debt directly issued by the U.S. government. Bloomberg Barclays U.S. Corporate Index is a broad-based benchmark that measures the investment grade, fixed-rate, taxable corporate bond market. Bloomberg Barclays U.S. Mortgage-Backed Securities Index is the MBS component of the U.S. Aggregate index and includes the mortgage-backed pass-through securities of Ginnie Mae (GNMA), Fannie Mae (FNMA), and Freddie Mac (FHLMC). Bloomberg Barclays CMBS ERISA-Eligible Index is the CMBS component of the U.S. Aggregate index and includes CMBS investment grade securities that are ERISA eligible under the underwriter’s exemption. Bloomberg Barclays Asset-Backed Securities Index is the ABS component of the U.S. Aggregate index and includes credit and charge cards, autos and utilities. ICE BofA Merrill Lynch U.S. All Capital Securities Index is a subset of the BofA Merrill Lynch U.S. Corporate Index including all fixed-to-floating rate, perpetual callable and capital securities. Bloomberg Barclays High Yield 2% Issuer Capped Index measures the market of USD-denominated, non-investment grade bonds and limits each issue to 2% of the index. The Credit Suisse Leveraged Loan Index is designed to mirror the investable universe of the U.S. dollar-denominated leveraged loan market. Loans are added to the index if they qualify according to the following criteria: The highest Moody’s/S&P ratings are Ba1/BBB+, only funded term loans are included, and the tenor must be at least one year. Bloomberg Barclays Emerging Market USD Aggregate Index is a flagship hard currency Emerging Markets debt benchmark that includes USD denominated debt from sovereign, quasi-sovereign, and corporate EM issuers. Bloomberg Barclays Global Aggregate Unhedged Index measures the performance of global bonds. It includes government, securitized and corporate sectors and does not hedge currency. One basis point equals .01%, or 100 basis points equal 1%.
A word on risk
Investing involves risk; principal loss is possible. Debt or fixed income securities are subject to market risk, credit risk, interest rate risk, call risk, derivatives risk, dollar roll transaction risk and income risk. As interest rates rise, bond prices fall. Below investment grade or high yield debt securities are subject to liquidity risk and heightened credit risk. Preferred securities are subordinated to bonds and other debt instruments in a company’s capital structure and therefore are subject to greater credit risk. Foreign investments involve additional risks, including currency fluctuation, political and economic instability, lack of liquidity and differing legal and accounting standards. Asset-backed and mortgage-backed securities are subject to additional risks such as prepayment risk, liquidity risk, default risk and adverse economic developments. The value of convertible securities may decline in response to such factors as rising interest rates and fluctuations in the market price of the underlying securities. Senior loans are subject to loan settlement risk due to the lack of established settlement standards or remedies for failure to settle. These investments are subject to credit risk and potentially limited liquidity, as well as interest rate risk, currency risk, prepayment and extension risk, and inflation risk.
Investors should contact a tax advisor regarding the suitability of tax-exempt investments in their portfolio. If sold prior to maturity, municipal securities are subject to gain/losses based on the level of interest rates, market conditions and the credit quality of the issuer. Income may be subject to the alternative minimum tax (AMT) and/or state and local taxes, based on the state of residence. Income from municipal bonds held by a portfolio could be declared taxable because of unfavorable changes in tax laws, adverse interpretations by the Internal Revenue Service or state tax authorities, or noncompliant conduct of a bond issuer. It is important to review your investment objectives, risk tolerance and liquidity needs before choosing an investment style or manager.
This information represents the opinion of Nuveen, LLC and its investment specialists and is not intended to be a forecast of future events and or guarantee of any future result. Information was obtained from third party sources which we believe to be reliable but are not guaranteed as to their accuracy or completeness. There is no assurance that an investment will provide positive performance over any period of time.
The investment advisory services, strategies and expertise of TIAA Investments, a division of Nuveen, are provided by Teachers Advisors, LLC and TIAA-CREF Investment Management, LLC. Nuveen Asset Management, LLC, Symphony Asset Management LLC and NWQ Investment Management Company LLC are registered investment advisers and investment specialists of Nuveen, LLC.