Weekly Fixed Income Commentary: Rising inflation data boost Treasury yields
Weekly fixed income update highlights
- Most fixed income market segments weakened, including mortgage-backed securities, investment grade and high yield corporates, preferreds, convertibles and emerging markets.
- Loans had positive total returns, while high yield corporates and emerging markets both outperformed versus similar-duration Treasuries despite their negative total returns.
- Municipal bond prices ended the week unchanged. New issue supply was $10.3B, with strong flows of $1.9B. This week’s new issue supply is $11.4B.
U.S. Treasury yields rose last week after another high U.S. inflation print and a surprisingly weak 30-year Treasury auction. Spread assets felt the pressure, but we expect strong fundamentals to support credit market returns moving forward.
Watchlist
- Treasury yields rose last week, and we continue to anticipate higher rates into year-end.
- Spread assets were pressured by higher rates, but we expect strong fundamentals to support returns moving forward
- Municipal bonds are unlikely to remain so rich.
Investment views
Zero/negative global interest rate policy remains a key market support. Investors continue to focus on tapering and an eventual increase in interest rates.
Unprecedented global fiscal stimulus should continue to boost consumption and growth into next year.
Record supply of investment grade corporates has been followed by high levels of issuance from high yield, middle market loans and the broadly syndicated loan market. Taxable municipal supply also continues to grow.
We favor a risk-on stance, focused on credits with durable free cash flow and solid balance sheets across a wide range of sectors. Mid-quality rating segments appear particularly attractive. Essential service municipal bonds also look compelling.
Key risks
- Inflation rises in a disorderly way, negatively impacting asset values.
- Policymakers remove accommodation too rapidly, undermining the global economic expansion.
- Further complications with the COVID-19 vaccine rollout and Delta or future variants.
- Geopolitical flare-ups: China, Russia, Turkey, Iran.
High yield corporates get boost from their lower duration
U.S. Treasury yields rose across the curve last week, with both 2- and 10-year yields ending 11 basis points (bps) higher. Most of the increase happened on Wednesday, due to high inflation data and a weak 30-year auction. Headline consumer prices rose 0.9% month-over-month, taking the year-over-year rate to 6.2%, the fastest rate since 1990. The monthly data partially reflected familiar factors that are unlikely to be sustained into next year, such as rising gas and auto prices. However, the inflationary pressures appear to be broadening, with no categories showing offsetting price declines as they typically do. Given the higher inflation numbers and pressure on long-end Treasuries, the 30- year auction met with very weak demand.
Investment grade corporates weakened, as the selloff in Treasuries pressured returns, returning -0.99% last week and underperforming similar-duration Treasuries by -15 bps. Spreads ended the week 1 bp wider at 88 bps, in line with the average level this year, though 9 bps wider than the tightest levels reached in June. The technical backdrop was favorable, though not enough to offset the pressure from rates, as the asset class saw inflows of $1.8 billion and new supply of $22 billion.
High yield corporates performed relatively better, helped by their lower duration, returning -0.25% but outperforming similar-duration Treasuries by 26 bps. New issuance was high at $15 billion, though inflows totaled $2.6 billion. Since April, three of the four largest weekly inflows have been in the last four weeks. Loans performed well, returning 0.17%, as their floating-rate attribute makes higher rates a tailwind. Loans also saw strong inflows at $970 million. In both markets, lower-rated segments outperformed, with CCC bonds returning 0.59% and CCC loans up 0.61%.
Emerging markets also outperformed compared to Treasuries by 41 bps, though total returns were negative at -0.32%. Similar to the dynamic in U.S. high yield, the asset class saw strong retail inflows of $1 billion into hard currency funds. Attention was focused on the China property sector, with another major selloff at the start of the week. The weakness fed into investment grade-rated names for the first time, with many high-rated bonds weakening -15 to -20 points in price. However, conditions stabilized later in the week after reports circulated that the government will alter policies to support the sector, plus monthly mortgage origination numbers beat expectations.
High yield muni demand recovers
Municipal bond prices rallied early last week, then sold off due to disappointing inflation data, ending the week basically unchanged.
Consumer Price Index (CPI) data showed inflation trending at a 30-year high. While Treasuries sold off considerably on the news, municipal yields wavered but ultimately finished relatively unchanged for the week. One reason for this stability is the strong demand for tax-exempt income. CPI is only a snapshot, and we believe the Fed has time to control inflation first by tapering purchases, then raising short-term interest rates. The onus is on the Fed to show that it intends to aggressively fight inflationary pressures. Otherwise, we could see more upward pressure on interest rates in both Treasuries and municipal bonds.
The District of Columbia issued $657 million general obligation bonds (rated Aaa/AA). The deal was priced to sell, but some bonds traded at a slight concession in the secondary market. For example, 5% coupon bonds due in 20 years came at a yield of 1.47%. Those bonds traded at a yield of 1.49% (or 2 basis points cheaper) in the secondary, as dealers wanted to keep moving inventory.
High yield municipal fund flows came roaring back last week at $1.22 billion. Yields have declined on average for three consecutive weeks, likely boosting investors’ confidence. Puerto Rico’s GO restructuring appears on track, and would ultimately return nearly $7 billion to current bondholders. The infrastructure bill does not include macro-level municipal bond features, but it could materially benefit certain muni-centric sectors and specific issuers in the utility and transportation sectors. This week’s high yield new issue calendar remains robust. Last week, most deals were heavily oversubscribed. But several problematic deals remain unable to clear the market, demonstrating the market’s continued vigilance.
The Fed must show it intends to fight inflationary pressures. Otherwise, we could see more upward pressure on rates in both Treasuries and munis
In focus: Infrastructure passes, finally
President Biden is expected to sign the $1.2 trillion bipartisan Infrastructure Investment and Jobs Act (IIJA) bill into law today.
While pared down from the original $2 trillion, this bill represents the largest federal infrastructure investment in more than a decade, with $550 billion in new spending. Major provisions include:
>$178 billion for power & water systems
>$158 billion for transit (rail, public transit, airports, ports, safety)
>$110 billion for roads, bridges and major infrastructure projects
>$65 billion for broadband infrastructure
>$37 billion for other projects, including environmental remediation, electric vehicle plug-in infrastructures, electric bus/transit and reconnection communities
Tax increases are not required, with funding largely coming from diverted and unspent money from other programs.
Uncertainty remains regarding how the funds will be disbursed. Projects could be funded through existing formula-based programs, or through new grant programs. Regardless, it will require federal, state and local coordination.
Next on the Congressional agenda is the $1.9 trillion Build Back Better bill, which includes many of the social spending provisions stripped from the IIJA. Possible tax increases are under debate, though nothing is concrete. Also pending is the final decision on the debt ceiling.
Performance: Bloomberg L.P.
Issuance: The Bond Buyer, 12 Nov 2021.
Fund flows: Lipper.
New deals: Market Insight, MMA Research, 10 Nov 2021.
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.
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