Weekly Fixed Income Commentary: Treasury yields rise again on stronger inflation data
Weekly fixed income update highlights
- Treasuries, investment grade corporates, taxable munis, MBS and emerging markets had negative total returns.
- Preferreds, high yield corporates and senior loans advanced last week.
- Municipal bond yields rose slightly. New issue supply was $8.1B with outflows of -$117M. This week’s new issuance is less than $5.0B.
U.S. Treasury yields rose again after U.S. consumer price inflation surprised marginally to the upside. The European Central Bank (ECB) delivered a dovish hike last week, and all eyes are on the U.S. Federal Reserve this week.
Watchlist
- 10-year U.S. Treasury yields increased slightly, but we anticipate modest declines over the rest of 2023.
- Spread assets outperformed 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.
Treasury yields are likely to fall slightly this year, and we expect the 10-year Treasury yield to end 2023 around 3.75%.
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.
Corporate bond markets see heavy issuance and inflows
U.S. Treasury yields rose again last week after consumer price inflation surprised marginally to the upside. Core inflation came in at 0.3% month-over-month, slightly hotter than expected, with a sizable rebound in core services inflation excluding shelter, which rose at the fastest rate in almost a year. Separately, retail sales and industrial production both matched expectations, showing steady growth. The European Central Bank (ECB) delivered a dovish hike, raising policy rates by 25 basis points (bps), but suggesting it may be done with its hiking cycle, pending incoming inflation data.
Investment grade corporates weakened, returning -0.35% for the week but beating similar-duration Treasuries by 8 bps. New supply was heavy, with around $34 billion of new deals compared to expectations for closer to $25 billion. Overall, the new issuance was 4.3x oversubscribed and came with tight pricing, averaging only 3 bps of concessions. The supply was offset by strong inflows, with $2 billion entering the market last week. Inflows total $157 billion year-to-date, or around 4.5% of asset class AUM.
High yield corporates outperformed, returning 0.19% for the week and outpacing similar-duration Treasuries by 30 bps. Senior loans returned 0.50%. As with investment grade, the new issuance market was busy, with over $9.5 billion of new deals coming in both the high yield bond and senior loan markets. Inflows were strong as well, with $81 million entering high yield funds and $343 million going into loan funds.
Emerging markets sold off, returning -0.17% for the week but outperforming similar-duration Treasuries by 18 bps. Hard currency sovereign spreads tightened -7 bps, with most of the gains driven by high yield names including Ghana (3 pts), El Salvador (2 pts) and Egypt (2 pts). Unlike other major asset classes, emerging markets funds saw another week of outflows, with $467 million exiting hard currency funds and $529 million leaving local currency funds.
High yield munis experiencing a supply constraint
The municipal bond market was range bound last week, with yields ending slightly higher. New issuance was priced to sell and fund flows were negative yet again. This week’s light new issuance should be priced to sell and well received.
Investor confidence has been boosted by outsized yields not seen for more than a decade. At it’s meeting this week, the Fed must renew its unequivocal commitment to fighting inflation, raising rates to whatever yields necessary. Should the Fed fail to do this, the market will have to reassess what constitutes fair value.
The municipal market remains orderly. Institutions continue to rearrange portfolios and retail buyers are active. New issue supply is priced to sell and should continue through year end. We are constructive on fixed income in general and tax-exempt bonds specifically.
Dormitory State of New York (DSNY) issued $889 million state personal income tax revenue bonds (rated Aa1/AA+). Some bonds traded at a slight premium after the deal was free to trade. For example, 5% coupon bonds due in 2031 came at a yield of 3.30% and traded at a 1 bps premium in the secondary market. This premium is seen as a win for the market, as New York is expected to be a prolific issuer through year end. Demand remains strong, given the premiums in the secondary market.
The high yield municipal market remains unusually quiet. Despite index average yields hovering at 6%, fund flows remain flat to slightly negative. We believe a significant supply constraint is going unappreciated. The intricacies of bond structures are creating a wide dispersion of relative value in this market.
We believe a significant high yield muni supply constraint is going unappreciated.
In focus: The ECB grits its teeth and raises interest rates
In a closely watched decision, the European Central Bank (ECB) hiked rates to an all-time peak, as it felt the need to enhance its battle against rising consumer prices.
The ECB’s policy statement noted that inflation had cooled but “is still expected to remain too high for too long.” Headline eurozone inflation registered 5.3% year-over-year in August, unchanged versus July but half of last October’s 10.6% reading. Core inflation, which strips out food and energy prices, was unchanged at 5.3% in August, as distortions interrupted the downward inflation trajectory. With both readings staying well above the ECB’s 2% target, the central bank lifted its key deposit rate by 25 bps, to 4%. Looking ahead, the ECB expects average inflation of 5.6% in 2023, 3.2% in 2024 — upward revisions reflecting higher energy costs — and 2.1% in 2025.
However, the central bank significantly lowered its economic growth projections. It now anticipates eurozone GDP to expand by 0.7% in 2023, 1.0% in 2024 and 1.5% in 2025, as the higher cost of capital dents domestic demand and international trade slows. The ECB also hinted that its key policy rates have peaked. The policy statement noted that “interest rates have reached levels that, maintained for a sufficiently long duration, will make a substantial contribution to the timely return of inflation to the target.” In the wake of the ECB’s meeting, the euro fell to a three-month low versus the U.S. dollar.
Performance: Bloomberg L.P.
Issuance: The Bond Buyer, 15 Sep 2023.
Fund flows: Lipper.
New deals: Market Insight, MMA Research, 13 Sep 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.