Weekly Fixed Income Commentary: Economic data push Treasury yields higher
Weekly fixed income update highlights
- Total returns were positive in high yield corporates and senior loans, and excess returns were positive in high yield corporates, emerging markets, preferreds and securitized sectors.
- Treasuries and investment grade corporates produced negative total returns.
- Municipal bond yields increased. New issue supply was $9.2B and fund outflows were -$121M. This week’s new issuance is estimated to be undersized at $4B.
U.S. Treasury yields moved higher last week, as strong U.S. economic data and hawkish U.S. Federal Reserve rhetoric caused markets to push back expectations for rate cuts. The market is now pricing fewer than five rate cuts this year, down from more than six cuts earlier this year.
Watchlist
- The 10-year U.S. Treasury yield rose last week, but we anticipate declines in overall rates in the months ahead.
- Spread assets broadly outperformed Treasuries.
- Increased seasonal supply should provide an attractive entry point for municipal bonds.
Investment views
Rates have probably peaked for this cycle, as attention pivots toward rate cuts in response to softer growth and easing inflation.
The underlying growth outlook remains healthy thanks to strong consumer balance sheets and solid levels of business investment. This combination should keep corporate defaults low.
Risk premiums may widen further, with entry points for taxable fixed income likely to become more attractive over the coming quarters. Credit selection is key as we search for bonds with favorable income and solid fundamentals.
Key risks
- Inflation fails to continue moderating as expected, weighing on asset prices.
- Policymakers unsuccessfully juggle fighting inflation with supporting economies still struggling to gain traction.
- Geopolitical flare-ups intensify: Israel, China, Russia and Iran.
High yield corporates see healthy inflows
U.S. Treasury yields rose last week, as U.S. economic data showed resilience and remarks from Fed Chair Powell continued to lean hawkish. The ISM services index rebounded to 53.4 for January, up 2.9 percentage points for its biggest gain in a year. Meanwhile, Powell continued to push back against market pricing for a possible rate cut at next month’s Fed meeting. The market is now pricing fewer than five rate cuts this year, down from more than six cuts earlier this year. That movement pressured Treasury yields higher across the curve, with the 10-year yield rising 15 basis points (bps) for the week to 4.18%.
Investment grade corporates weakened, returning -0.95% for the week. The asset class performed in line with similar-duration Treasuries. The weakness came amid the increase in rates, despite a surge in inflows. More than $7 billion entered investment grade funds for the week, the largest weekly inflow since July 2021. At the same time, the new issue market remained heavy, with $45 billion pricing for the week, almost double the roughly $25 billion expected. Demand for the new issuance was robust, with average oversubscription rates of 3.9x, leading to average new issue concessions of around 3.5 bps, in line with levels that have prevailed this year.
High yield corporates outperformed, returning 0.13% for the week and outpacing similar-duration Treasuries by 49 bps. The asset class was boosted by a healthy inflow of $549 million. Separately, senior loans returned 0.22% for the week, despite outflows of -$273 million. Both asset classes continued to see continued heavy supply. Despite high overall yield levels relative to recent history, spread levels are very tight and companies are finding it attractive to refinance deals at tight levels. The high yield market saw $6.1 billion of issuance and loans saw $13.6 billion.
Emerging markets were mixed, returning -0.30% for the week but beating similar-duration Treasuries by 50 bps. Spreads compressed in both sovereign and corporate markets, with high yield names leading the way in both markets. Emerging markets funds saw their first inflows in two months, led by a $231 million inflow in local currency funds, which was partially offset by a -$150 million outflow from hard currency funds.
Municipal bond yields rise with Treasuries
Municipal bond yields ended last week higher. Short- and long-term yields rose 12 bps and 10 bps, respectively. The new issue calendar was well received, while fund outflows per Lipper returned at -$121 million (-$443 million for exchange-traded funds). However, ICI data shows municipal fund flows have netted a positive $4.3 billion so far in 2024. This week’s new issue supply should be undersized and well received. In fact, the market would welcome a larger calendar.
The municipal market sold off in sympathy with Treasuries. Munis remain rich to taxable bonds, but municipal yields are their highest in a few years. So we expect munis to remain well bid. We would consider any selloffs as a potential buying opportunity. Demand is high, with too much cash chasing too few bonds.
The state of Wisconsin issued $248 million general obligation bonds (rated Aa1/AA+). Although the market continued to sell off during the week, some bonds from this deal traded later at the same yield as where they were issued. For example, 5% bonds due in 2034 came at a yield of 2.51% and traded in the secondary market at the original yield. This demonstrates the market’s continued need for-tax exempt bonds.
The high yield municipal market inflows continued last week, aas investors remained steadfast through the latest rebound in U.S. Treasury rates. New issue deals remain heavily oversubscribed. A Washington, D.C., charter school deal was 11x oversubscribed and bumped 15 bps tighter in final pricing. We are tracking 11 high yield muni deals coming this week across land-secured, student housing, multi-family housing, charter schools, senior living and industrial development sectors.
Municipal fund flows have netted a positive $4.3 billion so far in 2024.
In focus: Senior loans look to navigate uncertainty
Loans have started the year by posting a modest total return (+0.98%) and a healthy 9.33% yield — tops among major fixed income segments. A strategic allocation has benefited investors.
Much to the Fed’s satisfaction, inflation continues to moderate, even as the central bank has yet to declare victory over rising prices. At its 31 January meeting, Chair Jerome Powell all but dashed hopes for a March rate cut. And with the economy showing further signs of strength, as evidenced by January’s robust job creation, the Fed is in no rush to take its foot off the brakes. However, Powell has assured markets that easier policy is forthcoming this year. Loans have performed well during periods of rising and declining rates, reinforcing the case for a strategic allocation to the asset class.
Meanwhile, issuers of senior loans are being forced to endure steep borrowing costs, which have contributed to a pickup in default rates. An economic slowdown later in the year — a distinct possibility, in our view — would also pressure issuers, mainly those entering this period with weaker credit profiles.
Given these challenges, we believe investors looking to benefit from an allocation to loans are better served by active management. Pairing deep fundamental research with top-down views can help managers spot loans across the full spectrum of ratings whose fundamental risks have been mispriced by the market.
Performance: Bloomberg L.P.
Issuance: The Bond Buyer, 09 Feb 2024.
Fund flows: Lipper.
New deals: Market Insight, MMA Research, 07 Feb 2024.
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 Municipal Index; high yield municipal: Bloomberg High Yield Municipal Index; short duration high yield municipal: S&P Short Duration Municipal Yield Index; taxable municipal: Bloomberg Taxable Municipal Bond Index; U.S. aggregate bond: Bloomberg U.S. Aggregate Bond Index; U.S. Treasury: Bloomberg U.S. Treasury Index; U.S. government related: Bloomberg U.S. Government-Related Index; U.S. corporate investment grade: Bloomberg U.S. Corporate Index; U.S. mortgage-backed securities; Bloomberg U.S. Mortgage-Backed Securities Index; U.S. commercial mortgage-backed securities: Bloomberg CMBS ERISA-Eligible Index; U.S. asset-backed securities: Bloomberg Asset-Backed Securities Index; preferred securities: ICE BofA U.S. All Capital Securities Index; high yield 2% issuer capped: Bloomberg High Yield 2% Issuer Capped Index; senior loans: Credit Suisse Leveraged Loan Index; global emerging markets: Bloomberg Emerging Market USD Aggregate Index; global aggregate: Bloomberg Global Aggregate Unhedged Index.
This material is not intended to be a recommendation or investment advice, does not constitute a solicitation buy, sell or hold a security or an investment strategy, and is not provided in a fiduciary capacity. The information provided does not take into account the specific objectives or circumstances of any particular investor, or suggest any specific course of action. Investment decisions should be made based on an investor’s objectives and circumstances and in consultation with his or her financial professionals.
The views and opinions expressed are for informational and educational purposes only as of the date of production/writing and may change without notice at any time based on numerous factors, such as market or other conditions, legal and regulatory developments, additional risks and uncertainties and may not come to pass. This material may contain “forward-looking” information that is not purely historical in nature. Such information may include, among other things, projections, forecasts, estimates of market returns, and proposed or expected portfolio composition. Any changes to assumptions that may have been made in preparing this material could have a material impact on the information presented herein by way of example. Performance data shown represents past performance and does not predict or guarantee future results. Investing involves risk; principal loss is possible.
All information has been obtained from sources believed to be reliable, but its accuracy is not guaranteed. There is no representation or warranty as to the current accuracy, reliability or completeness of, nor liability for, decisions based on such information and it should not be relied on as such. For term definitions and index descriptions, please access the glossary on nuveen.com. Please note, it is not possible to invest directly in an index.
Important information 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.
Nuveen, LLC provides investment solutions through its investment specialists.
This information does not constitute investment research as defined under MiFID.