Weekly Fixed Income Commentary: Strong employment data boost Treasury yields
Weekly fixed income update highlights
- Total returns were once again broadly negative across fixed income sectors, but most pronounced among longer-duration and higher-yielding asset classes.
- Preferreds, emerging markets and taxable municipals experienced the steepest negative returns.
- Municipal bond yields increased once again. New issue supply was priced to sell with outflows of -$1.2B. This week’s new issuance is estimated at $4.8B.
U.S. Treasury yields continued increasing and the yield curve steepened after the stronger-than-expected U.S. jobs report on Friday. While expectations for an eventual decline in rates remain, we may see elevated rates for longer.
Watchlist
- 10-year U.S. Treasury yields increased, but we anticipate modest declines over the rest of 2023.
- Spread assets generally underperformed Treasuries.
- Increased seasonal supply should provide an attractive entry point for municipal bonds.
Investment views
“Higher for longer” rates remains as a theme, as central banks battle to control inflation. Higher interest rates are likely to cause additional volatility.
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.
We favor selectively taking on risk in this environment of attractive prices and yields. Credit selection is key as we search for bonds with favorable income and solid fundamentals.
Key risks
- Inflation fails to moderate as expected, weighing on asset prices.
- Policymakers tighten too rapidly, undermining the global economic expansion.
- Geopolitical flare-ups: China, Russia, Turkey, Iran and Israel.
Investment grade corporate yields reach 2023 highs
U.S. Treasury yields moved sharply higher last week. The 10-year yield rose 23 basis points (bps) to a year-to-date high of 4.80%. The selloff began early in the week, as fears of a U.S. government shutdown abated and most economic readings outperformed market expectations. Conditions intensified on Friday, with nonfarm payrolls for September sharply exceeding consensus estimates. The 30-year yield also surged, reaching an intra-year high and briefly touching 5.00% before settling at 4.97%. Odds edged higher for one more U.S. Federal Reserve rate hike before year-end. The 2-year yield increased by 4 bps to 5.08%. The curve continued to steepen as markets repriced for a higher-for-longer environment. The difference between 2- and 10-year yields ended the week at -29 bps.
Investment grade corporates came under pressure, returning -1.44% for the week and lagging similar-duration Treasuries by -16 bps. Overall index yields edged 15 bps higher to 6.18%, a level not seen since last year. As investors broadly shunned risk assets, spreads inched 4 bps wider to 125 bps. Rate volatility impacted new issues: 10 issuers priced $8.9 billion in supply, falling short of the estimated $15-20 billion supply forecast. High quality issuance remained a theme, as did maturities inside 10 years. New issuance is expected to stay light and perhaps move even quieter if rate volatility persists.
High yield corporates weakened, returning -1.21% for the week and underperforming similar-duration Treasuries by -84 bps. Senior loans also posted negative results of -0.23%. Higher quality issues outperformed as volatility increased amid broader macro uncertainty. High yield bond spreads widened 35 bps, driven largely by the significant move in rates. High yield and loan funds saw outflows of -$2.6 billion and -$942 million, respectively.
Emerging markets sold off, returning -1.66% for the week and lagging similar-duration Treasuries by -62 bps. Within sovereigns, spreads widened modestly for investment grade names (3 bps) but significantly for high yield (30 bps). Outflows increased sharply, with -$1.9 billion exiting the hard currency asset class. The move in rates and market volatility resulted in subdued new issuance at only $2 billion.
The municipal bond yield curve represents value
Municipal bond yields rose again last week. The new issue calendar was priced to sell and well received. Some deals were pulled due to weak market conditions. Weekly fund flows were negative, and this week’s new issue calendar is muted. Deals will likely need to be priced at distressed levels to clear the markett.
We are bullish on the municipal bond market and expect fixed income investments in general will look attractive by mid-2024. Tax-exempt muni yields are at or near 10-year highs. We believe investors should remain allocated to muni bonds and consider implementing tax-loss swaps, as we see opportunities to increase tax-exempt income in portfolios. Also, similar to Treasuries, the entire muni bond yield curve represents value.
We expect muni market volatility to continue through the end of the year due to heavier supply. Also, dealers are reluctant to support the muni market with strong bidding in the secondary market. We would see any selloffs as a buying opportunity.
San Diego International Airport issued $1 billion airport revenue bonds (rated A1/NR). The bonds were subject to the alternative minimum tax (AMT). The deal was priced to sell and well received.
We believe investors should remain allocated to muni bonds and consider implementing tax-loss swaps.
In focus: 4Q 2023 outlook: laying out the fixed income landscape
In our 2023 fourth quarter outlook, Nuveen’s Global Investment Committee (GIC) highlighted some of our best investment ideas.
The GIC believes the high current yields — which correspond to low prices — available on many asset classes make an attractive investment backdrop. And although some central banks will continue to raise rates, we think the Fed is near the end of its tightening cycle. That should help stabilize the market in what has been another challenging year for fixed income. With an eye toward modestly extending duration and favoring higher-quality credits, the GIC sees income generation potential in:
Senior loans, which offer attractive spread levels compared to other credit sectors, along with a compelling yield (10.4%).
High yield corporates, particularly the BB area of the market.
Select emerging markets debt, with a focus on countries whose central banks are further along in the fight against inflation and are therefore more likely to begin lowering rates.
Municipal bonds. According to the GIC, fundamentals and market technicals are solid, and municipals’ longer-duration profile should provide a tailwind if rates have peaked. Compelling opportunities exist in both high yield credits and bonds with maturities exceeding 15 years, both of which appear undervalued.
Performance: Bloomberg L.P.
Issuance: The Bond Buyer, 06 Oct 2023.
Fund flows: Lipper.
New deals: Market Insight, MMA Research, 04 Oct 2023.
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.