Weekly Fixed Income Commentary: Provisional trade deal stokes Treasury yields
- High yield corporates and preferred securities outperformed all other sectors and delivered a positive total return.
- Municipal markets sold off last week, but we don’t expect that will be a long-term trend.
- The global aggregate sector outperformed U.S. markets, buoyed by stronger returns in the European region.
Prospects of a U.S./China trade “truce” stoked a strong risk-on sentiment, significantly boosting U.S. Treasury yields. The increase offset a majority of the previous week’s declines. Mixed economic data and Treasury issuance did not disrupt the move. Market-based expectations for a Federal Reserve (Fed) rate cut in October stand at just over 70%.
Trade optimism drives Treasury yields higher
A strong risk-on market tone pushed Treasury yields significantly higher last week, stoked by prospects of a U.S./China trade “truce.”1 The increase offset most of the previous week’s drop in rates for 2- to 5-year maturities, and more than eclipsed earlier declines in longer maturity yields.1 Mixed economic data and Treasury issuance did little to disrupt the increase, and yields climbed nearly every day with only a brief pullback on Tuesday.1 Progress on both China trade and Brexit caused Treasury yields to rise most significantly on Thursday and Friday.1 Nevertheless, Treasury yields remain 80 to 95 basis points (bps) lower for the year.1
The risk-on market tone supported non-Treasury sectors, although most experienced negative total returns for the week.1 High yield corporates and preferred securities outperformed all other sectors and delivered a positive weekly total return.1 Preferred securities are one of the few sectors enjoying positive returns so far in October, and have experienced the highest total return in 2019.1 Despite negative total returns, all other sectors except asset-backed securities outperformed similar-duration Treasuries.1 Last week’s strong relative performance allowed all sectors to match similar-duration Treasuries for the year.1 The global aggregate sector outperformed U.S. markets, buoyed by stronger returns in the European region.1
The Fed announced it would buy $60 billion in Treasury bills per month to boost reserves. This program was clearly differentiated from similar quantitative easing purchases. The markets’ probability of a Fed rate cut at the October meeting increased to over 82% mid-week before falling to end the week at slightly over 70%.
Municipal fund flows were positive for the 40th consecutive week at $1.39 billion.
Despite a selloff, we think municipals remain attractive
The municipal bond market sold off last week, along with U.S. Treasuries.1 New issuance of $8.5 billion was priced to sell and well received.2 Fund flows were positive for the 40th consecutive week at $1.39 billion.3 This week’s new issue calendar is expected to be $11.6 billion ($4 billion taxable).2 Inflows year to date stand at $71.3 billion, the highest on record.3
Investors were motivated to sell both municipal bonds and Treasuries last week, but we don’t see this as “panic” selling. Rather, we believe it was an unwinding of “panic buying” over the last couple of months, due to fears of potential recession and consequently much lower rates. However, trade talks between the U.S. and China are more promising, and the Fed indicated it would remain accommodative and lower rates as necessary to boost the U.S. economy. And a peaceful resolution to Brexit appears possible. So investors rotated out of bonds and into stocks.
However, pent-up demand remains on the sidelines to buy fixed income on any dips. This is especially true in municipals. Investors will likely take advantage of higher yields and a higher new issue calendar through the end of the year. We still believe rates will stay lower for longer.
The state of Oregon issued $191 million tax-exempt general obligation bonds (rated Aa1/AA+).4 The deal was well received, and underwriters lowered yields upon final pricing. However, some bonds traded at cheaper levels by the end of the week from where the deal sold, reflecting the broader market sell off.
High yield municipal fund flows showed one of the year’s strongest weekly paces at $527 million, despite continued rate volatility.3 This holiday-shortened week is expected to produce an increased number of deals, but the deal size continues to be limited and will again likely lead to heavy oversubscriptions and aggressive demand. We believe this demand is justified, as credit spreads are relatively wide and defaults remain near historical lows.
High yield corporate bonds outperform all sectors
High yield corporates rebounded, following two consecutive weeks of negative returns.1 With a shorter duration profile than many other non-U.S. Treasury sectors, high yield proved relatively resilient in the face of last week’s jump in interest rates.1 Overall, spreads narrowed by 29 basis points.1 Investors exhibited a degree of caution within the asset class, as higher-quality (BB) bonds continued to outperform B and CCC rated paper.1 Trading volumes were light, and fund flows were negative (-$1.5 billion).3 In the primary market, about $3 billion in new deals were issued.2
Investment grade corporate bonds ended their three-week winning streak.1 Total returns were in the red every day, despite still-positive technicals (strong demand in the face of limited supply) and mild spread tightening. Investment grade credit as a whole has a longer duration than most sectors, including Treasuries, making it more vulnerable to rising rates.
High yield corporates proved relatively resilient in the face of last week’s jump in interest rates.
Emerging markets (EM) debt finished near the middle of the pack among taxable sectors.1 Returns for the week were modestly negative as the impact of higher rates outweighed the benefits of renewed U.S./ China trade optimism.1 Most EM currencies strengthened, with the notable exception the Turkish lira, which tumbled amid news of that country’s military campaign into northeast Syria.
Taxable markets post 3Q gains
Taxable fixed income returns were broadly positive in a third quarter marked by two Fed interest rate cuts, falling global yields and muted inflation. Markets experienced some bouts of volatility amid a variety of headline risks, including U.S./China trade, an inverted yield curve and Brexit angst.
Longer-maturity U.S. Treasuries outperformed shorter-dated issues, causing the yield curve to flatten for the quarter.1 The 3-month/10-year yield gap remained inverted for all but one day of the quarter, stoking recession fears.1 After declining from a high of 2.13% in mid-July to a multiyear low of 1.47% in late August, the 10-year yield ended September at 1.68%, down 32 basis points for the full quarter.1
Investment grade corporate bonds returned a healthy 3.1%, thanks to solid fundamentals, low risk of credit downgrades and investors’ continued search for yield. Their high yield counterparts posted a more modest gain (+1.3%), tempered by strong risk-off sentiment in August.
Non-U.S. fixed income markets also delivered mildly positive returns. The global investment grade aggregate index (+0.7%) lagged emerging markets debt (+1.3%), which benefited from fund inflows and a dovish Fed.1
Current valuations in many areas of the bond market look stretched. In this environment, we favor late-cycle, defensive positioning with a moderate emphasis on spread sectors given their income advantages.
1 Bloomberg L.P
2 The Bond Buyer, 11 Oct 2019.
3 Lipper Fund Flows.
4 Market Insight, MMA Research, 9 Oct 2019.
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 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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