Weekly Fixed Income Commentary: Dashed hopes for a trade deal send Treasury yields lower
- Investment grade corporate bonds posted a positive return and outperformed all non-municipal fixed income categories.
- The municipal bond market rallied last week, but lagged U.S. Treasuries.
- Emerging markets debt posted a gain for the fourth time in five weeks.
U.S. Treasury yields declined last week, led by longer maturities.1 Market sentiment weakened after President Trump failed to announce progress on a U.S./China trade deal. Rates fell and the yield curve flattened in response. Market expectations reflect a low probability that the Federal Reserve (Fed) will cut rates again in December.
Treasury rates decline as trade optimism wanes
U.S. Treasury yields declined last week, led by long maturities, as optimism faded over a potential U.S./China trade deal.1 The entirety of the decline occurred in the middle of the holiday-shortened week.1 Due to few substantive economic releases, speeches by President Trump and Fed Chair Powell were the main focus. Market sentiment weakened after Trump did not announce a Phase One trade deal with China. Rates fell and the yield curve flattened in response, as markets reflected weaker future growth prospects.1 Chair Powell’s testimony largely reinforced that the Fed viewed monetary policy as being appropriately positioned and it would take a material change in its outlook to alter that policy.
Most non-Treasury sectors enjoyed positive total returns last week, but underperformed Treasuries.1 High yield corporates fared the worst and suffered a slightly negative total return.1 Senior loans and emerging markets also struggled, posting slightly positive returns well behind Treasuries.1 Investment grade corporates were one of only two sectors to outperform Treasuries, buoyed by a longer duration.1 The securitized sectors experienced the best relative returns, as commercial mortgage-backed and asset-backed securities were the only sectors to outperform similar-duration Treasuries.1 Despite weak performance last week, all non-Treasury sectors significantly outperformed similar-duration Treasuries for November and 2019 overall.1
Market-based expectations are low that the Fed will cut rates again in December. Odds of a rate cut at the next Fed meeting are just 4%. Probabilities show only a 70% chance of any rate cut between now and the end of 2020.
All non-Treasury sectors stand well ahead of similar-duration Treasuries for November and 2019 overall.
High yield municipal fund flows surge back to life
The municipal bond market rallied last week, but lagged U.S. Treasuries.1 The municipal new issue calendar was $11.8 billion, and was priced to sell and well received.2 Fund flows were positive for the 45th consecutive week at $1.2 billion.3 This week’s new issue calendar is expected to be outsized again at $12.8 billion.2 The unprecedented demand for tax-exempt income continues, with flows at an all-time high of $79.8 billion year to date.3
Fixed income in general has a solid tone, even as volatility remains elevated. For example, positive news on the U.S./China trade deal leads investors to over emphasize equities, causing bond prices to fall. When trade talks appear to stall, investors focus on bonds, sending bond prices higher. We expect rates to stay lower for longer, and see continued underperformance of municipals (due to outsized year-end supply) as a potential buying opportunity.
District of Columbia issued $1.3 billion tax-secured revenue bonds (rated Aa1/AAA).4 The deal was priced cheaply for such a highly rated credit, mainly to pique investor interest. It was well received and bonds later traded at premiums to their initial offering price.
High yield municipal bond yields again failed to reflect the volatility in the Treasury market, declining by only 4 basis points (bps) last week.1 Fund inflows surged back to life, adding $200 million mainly at the end of the week.3
The high yield municipal new issue calendar continues to reflect the potential for additional credit spread contraction as more deals are produced. We expect inflows to re-accelerate, reaffirming a strong technical tailwind into the end of the year.
Investment grade corporates see-saw back to a weekly gain
Investment grade corporate bonds posted a positive return last week and outperformed all non-municipal fixed income categories.1 The asset class has now alternated between a gain and a loss for seven consecutive weeks.1 Investment grade credit spreads were nearly unchanged (+1 bps), largely shrugging off U.S./China trade headlines, Hong Kong protests and U.S. impeachment hearings.1 Technicals remained strong, despite nearly $50 billion of new supply hitting the market.2 Fund flows were favorable, with a significant portion of demand coming from overseas.3
High yield corporate returns were slightly negative amid an uptick in risk aversion prompted by fading U.S./China trade optimism.1 Spreads widened (+10 bps) on the week, and high yield bond funds experienced modest outflows (approximately -$254 million).1,3 Within high yield, investors’ preference for better-quality issues remained intact, evidenced by the outperformance of BB and B rated securities versus their CCC counterparts.1
Investment grade corporate technicals remained strong, despite nearly $50 billion of new supply hitting the market.
Emerging markets (EM) debt posted a gain for the fourth time in the past five weeks.1 Performance was modestly positive despite spread widening in both sovereign and corporate markets. Ongoing unrest in Hong Kong and Chile dampened EM sentiment, as did weak Chinese GDP growth. EM currencies were generally weaker against the U.S. dollar.
Despite risk-on trade, credit-sensitive assets have lagged
Interest rates have been back on the rise and equities have moved higher, signaling investor confidence around U.S. economic growth and earnings. However, U.S. corporate credit market assets that should typically respond better to more positive sentiment remain out of favor.
As an example, CCC-rated assets have lower duration and are generally more sensitive to moves in the equity markets. These assets have underperformed higher-quality assets that would be expected to lag during periods of rising rates and a more bullish tone.5
What does this trend mean for investors? Risk premiums are beginning to normalize, and we believe investors may begin to be compensated again for owning credit-sensitive assets.
In this environment, we see potential value in floating rate senior loans, which have lagged the high yield market considerably recently. Loans have historically offered similar yield and spread to high yield investments with potentially less volatility.5 These credit sensitive assets offer investors an alternative to allocating to equities or traditional fixed income, and may allow investors to add yield with less volatility.
1 Bloomberg L.P
2 The Bond Buyer, 15 Nov 2019.
3 Lipper Fund Flows.
4 Market Insight, MMA Research, 13 Nov 2019.
5 Credit Suisse.
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
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