Weekly Fixed Income Commentary: Treasury yields decline as central banks hold steady
Weekly fixed income update highlights
- Total returns were positive across the board, including Treasuries, taxable munis, MBS, investment grade and high yield corporates, preferreds, emerging markets and senior loans.
- Municipal bond yields declined. New issue supply was only $3.4 billion and outflows totaled -$1.5B. This week’s new issuance is estimated at $9B.
The 10-year U.S. Treasury yield declined substantially last week after major central banks – including the U.S. Federal Reserve, European Central Bank and Bank of England – kept interest rates steady and economic data disappointed versus expectations.
- The 10-year U.S. Treasury yield declined sharply, and we anticipate further declines in overall rates in the months ahead.
- Spread assets outperformed strongly versus Treasuries.
- Increased seasonal supply should provide an attractive entry point for municipal bonds.
“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.
- Inflation fails to moderate as expected, weighing on asset prices.
- Policymakers tighten too rapidly, undermining the global economic expansion.
- Geopolitical flare-ups intensify: China, Russia, Turkey, Iran and Israel.
Corporate bonds rally strongly
U.S. Treasury yields rallied substantially last week, with the 10-year yield falling -26 basis points (bps) to end at 4.57%. That was the biggest weekly rally since March. 2-year yields dropped -16 bps. The Federal Reserve, European Central Bank and Bank of England kept rates steady at their policy meetings. Separately, economic data was weaker than expected. The ISM manufacturing index fell to 46.7, indicating contraction and approaching cyclical lows. Nonfarm payrolls were softer-than-expected, with 150,000 new jobs in October but -101,000 in downward revisions to the prior two months. The unemployment rate also ticked higher again to 3.9%.
Investment grade corporates rallied strongly, returning 2.08% for the week and beating similarduration Treasuries by 29 bps. This weekly performance was the best in a year and the second-best post-Covid. Inflows returned, with $1.7 billion entering the asset class, partially reversing the sizeable outflow from the prior week. Yields fell back to 6% overall, down -28 bps for the week. With that rally in rates, issuers returned to the market more substantially. Eighteen issuers brought $29 billion of total new supply, nearly half from the financial sector. With rates remaining accommodative, supply is expected to be healthy again this week, with estimates at around $40 billion.
High yield corporates also gained strongly, returning 2.75% and outpacing similar-duration Treasuries by 179 bps. Senior loans joined the rally, gaining 0.30%. The rally was initially led by higherquality names, but the fall in rates ultimately drove a rally across the spectrum, with CCC corporates returning 1.62% for the week. Outflows returned, with -$953 million leaving high yield funds. Loan funds saw inflows of $126 million. New issuance was muted, with $1 billion pricing in high yield and $1.3 billion in loans.
Emerging markets rallied as well, returning 2.12% for the week and beating similar-duration Treasuries by 56 bps. The fall in core government rates and lack of hawkish commentary from the Fed sparked a 1.44% depreciation in the dollar, which helped the emerging markets asset class. High yield sovereigns had outsized gains, with spreads tightening -44 bps versus a move of -4 bps for investment grade sovereigns. As in U.S. high yield corporates, the strong performance came despite continued outflows, with -$831 million exiting hard currency funds and -$630 million leaving local funds.
Muni bond choppiness should continue through year end
Municipal bond yields declined strongly last week. Weekly new issue supply was well received and fund flows were negative once again. However, municipal bond exchange-traded funds saw one-day positive flows of $474 million. This week’s new issue supply will still need to be priced to sell to clear the market.
The 10-year muni AAA MMD rate curve ended last week -27 bps lower to 3.32%. We are constructive on municipal yields to be lower by mid-2024. We expect choppiness to continue through the end of this year due to continued heavy new issuance and outsized tax swaps.
Chicago Midway Airport issued $513 million revenue bonds, both AMT and non-AMT (rated A/A). The deal was priced to sell and well received. For example, underwriters lowered the yield 7 bps on the 5 1/2s due in 2053 AMT bonds. They were underwritten at a 5.48% yield.
High yield municipal fund outflows slowed last week. The Bloomberg High Yield Municipal Bond Index returned 2.62%, with the average yield decreasing -23 bps. Higher beta names like Buckeye Tobacco traded 40 bps tighter in yield as the market bid available bonds higher in anticipation of a market turn. High yield muni new issuance still offers highly attractive absolute yields. We are tracking heavy new issuance for this week that still offers attractive yields. New issuance appears more attractive than the secondary market, which was gobbled up last week with the change in market sentiment.
Investment grade corporates rallied, with the best weekly performance in a year and the second-best post-Covid.
In focus: The Fed pauses but leaves the door open
Last week, as expected, the Federal Reserve held interest rates at 5.25%- 5.50% for the second straight meeting but left open the possibility of a December rate hike.
In its policy statement, the Fed continued to characterize inflation as “elevated,” even as its preferred inflation barometer, the core Personal Consumption Expenditures (PCE) Price Index, fell to 3.7% year-over-year in September. Although this marked the PCE’s lowest level since May 2021, it stayed well above the Fed’s 2% target. Regarding the U.S. economy, the Fed’s assessment improved incrementally, from “solid” in September to “strong.”
During his post-meeting Q&A, Chair Jerome Powell explained that the Fed can afford to “proceed carefully” in its inflation battle. He explained that, “one of the reasons we have slowed the process down was to give monetary policy time to get into the economy.” But Powell’s guidance that the Fed will take upcoming decisions on a meeting-by-meeting basis leads us to believe that a 25 bps rate hike next month remains possible. In the meantime, financial conditions have tightened, driving up borrowing costs for both individuals and businesses.
U.S. Treasuries rallied in the wake of the Fed meeting, as investors dialed down their rate expectations over the next several quarters. The yield on the policy-sensitive 2-year note fell 7 bps, to a two-month low of 4.94%, while that of the bellwether 10-year security declined 4 bps, to 4.76%.
Taxable equivalent yield represents the yield that must be earned on a fully taxable investment to equal the yield on a municipal investment on an after-tax basis.
Performance: Bloomberg L.P.
Issuance: The Bond Buyer, 03 Nov 2023.
Fund flows: Lipper.
New deals: Market Insight, MMA Research, 01 Nov 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.
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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.
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