Weekly fixed income update highlights

• Treasuries, agencies, investment grade and high yield corporates, MBS, taxable munis and emerging markets all had negative total returns.
• In contrast, preferreds and senior loans enjoyed positive total returns.
• Municipal bond yields rose dramatically across the curve. New issue supply was outsized at $11.2B with substantial outflows of -$2.9B. This week’s new issuance remains robust at $8.5B.

U.S. Treasury yields rose again on stronger economic data in the U.S. In addition, inflation in the UK also surprised substantially to the upside, pushing global developed market bond yields higher.

Watchlist

• U.S. Treasury yields moved higher.
• Spread assets widened after recent gains.
• Increased seasonal supply should provide an attractive entry point for municipal bonds.

Investment views

“Higher for longer” emerges as a theme, as the Fed battles 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 businesses investment. This combination should keep corporate defaults low.

Treasury yields are likely to fall this year, and we expect the 10-year Treasury yield to end 2023 around 3.25%.

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.

Preferreds get a boost from positive tone around banks

U.S. Treasury yields rose again last week, with the 10-year yield ending 6 basis points (bps) higher at 3.57%. Front-end yields also rose, with 2-year Treasury yields up 8 bps. Stronger economic data in the U.S., highlighted by a positive print from the New York Fed’s manufacturing survey and robust flash PMIs, put upward pressure on yields. Inflation in the UK also surprised substantially to the upside, at 10.1% year-over-year, which pushed global developed market bond yields higher. However, other U.S. economic data were weak, including building permits, home sales, and jobless claims.

Investment grade corporates weakened slightly, returning -0.22% for the week, but the asset class outperformed similar-duration Treasuries by 7 bps. Overall, spreads tightened -1 bps, though financials led gains and tightened -6 bps. Large, national bank earnings were generally strong, and there have been no negative surprises from regional banks. The positive tone around banks also helped preferreds, which returned 0.46% for the week and beat similar-duration Treasuries by 66 bps. The new issuance market was active at around $26 billion, the vast majority from major banks.

High yield corporates lagged after recent outperformance, returning -0.33% and underperforming similar-duration Treasuries by -16 bps. BB rated corporates have been a popular overweight recently, and spreads on that market segment compressed to only 108 bps over BBBs, which prompted some investors to take profits. Senior loans returned 0.19% for the week, despite another outflow of -$461 million. High yield funds had a large outflow of -$3.1 billion.

Emerging markets underperformed, returning -0.75% and lagging similar-duration Treasuries by -49 bps. Sovereigns weakened across the board, though high yield underperformed. The weakness was led by a few idiosyncratic countries, such as Egypt and Argentina, which weakened -3 to -4 points. In the face of underperformance, the EM asset class broke a streak of nine consecutive weekly outflows, highlighted by a $576 million inflow into local currency bond funds.

Municipal bond supply surge sends yields higher

Municipal bond yields rose dramatically across the curve last week. The 2-year tax-exempt yield ended the week 33 basis points higher, while the 30-year yield rose 22 bps. The new issue municipal calendar (taxable and tax-exempt) was outsized, and underwriters had to price deals cheaply to pique investor interest. Weekly fund flows were substantially negative. This week’s new issue calendar remains robust and will again need to be priced cheaply.

It was no surprise that municipal bonds sold off last week. They had been trading rich to taxable bonds for several weeks, a trend that changed due to an increase in supply. Also, spring is typically a slow time of year for bond reinvestment, when many investors are redeeming holdings to pay taxes. However, demand strengthened at the cheaper levels. We expect Treasury yields to remain range bound for the foreseeable future. This means municipal bonds may present a potential buying opportunity when yields rise.

The state of Illinois issued $2.3 billion general obligation bonds (rated A3/A-). The deal was priced to sell and very well received, later breaking to a premium in the secondary market. For example, 5.50% coupon bonds due in 2047 came at a yield of 4.50%. Those bonds traded in the secondary market at 4.32%.

High yield municipal bond yields changed on par with high grades on average last week, increasing by 17 bps. The short-duration area, where the credit spread curve remains inverted, is attractive on both a relative and absolute yield level. Investors are again faced with low supply to reinvest upcoming summer cash flows.

Municipal new issue supply is down 29% year-over-year, marking its slowest start since 2018.

In focus: Munis see unusually high new issuance

The municipal bond market underperformed to start last week, as significant new issuance and news of the sale of Silicon Valley Bank’s balance sheet spurred investors to reposition portfolios to prepare for liquidity.

Municipal new issue supply is down 29% year-over-year, marking its slowest start since 2018. However, issuance swelled to $12 billion last week, which projects to an annual figure of approximately $600 billion. This level is nearly double the current pace of $304 billion. Issuance was coupled with news that the FDIC is facilitating the sale of Silicon Valley Bank’s municipal balance sheet, estimated to be worth $6.5 billion.

This market liquidity came despite municipals trading richer versus Treasuries. Given this confluence, municipals sold off drastically to start last week, moving closer to historic averages relative to Treasuries. Monday’s decline was the largest since October. However, municipals strengthened toward the end of the week with back to back positive days.

We anticipate pockets of issuance to periodically offer attractive investment opportunities. But we believe issuance will remain relatively constrained, and this does not change our outlook for municipals moving forward. With the U.S. Federal Reserve nearing a pause in rate hikes and the economy showing signs of softening, we continue to see short-term mispricing as a potential buying opportunity.