Weekly fixed income commentary |09/09/2024 (2024)

Weekly fixed income update highlights

• Treasuries, investment grade and high yield corporates, MBS, taxable munis, preferreds, senior loans and emerging markets all experienced positive total returns.
• Municipal bond yields declined. New issue supply was $8.2B, and fund inflows were $963M. This week’s new issuance is $12.7B.

U.S. Treasury yields U.S. Treasury yields moved lower as U.S. economic data indicated further slowing, especially in the labor market. The shape of the yield curve now shows a positive slope for the first time since July 2022.

Watchlist

• 10-year U.S. Treasury yield fell last week as job creation slowed further.
• Spread sectors generally gained, but lagged the substantial rally in Treasuries.
• Increased seasonal supply should provide an attractive entry point for municipal bonds.

Investment views

Rates have probably peaked for this cycle, as attention pivots toward rate cuts in response to softer growth and easing inflation.

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.

Risk premiums may widen further, with entry points for taxable fixed income likely to become more attractive over the coming quarters. Credit selection remains key as we search for bonds with favorable income and solid fundamentals.

Key risks

• Inflation fails to continue moderating as expected, weighing on asset prices.
• Policymakers unsuccessfully juggle fighting inflation with supporting economies still struggling to gain traction.
• Geopolitical flare-ups intensify around the world.

Investment grade corporate issuance remains busy

U.S. Treasury yields fell further last week.with the 10-year yield ending -19 basis points (bps) lower at 3.71%. The 2-year yield fell more sharply, down -27 bps, resulting in a positively sloping yield curve for the first time since July 2022. The bond market rally progressed throughout the week, as a series of U.S. economic data came in broadly weaker than expected. ISM manufacturing data and overall job openings were lower than expected. On Friday, headline job creation was also lower than expected, at 142,000 in August. There were downward revisions to prior months, taking the recent trend to a new cyclical low. However, the unemployment rate fell by -0.1 percentage points (pp) to 4.2% after the 0.2 pp increase in July. Overall, the economy remains in expansion, but downside risks to the labor market continue to intensify.

Investment grade corporates advanced again, returning 1.27% for the week, but underperformed similar-duration Treasuries by -35 bps. After an active August, the new issuance market was busy again to start September, with $80 billion pricing over the U.S. holiday-shortened week. That deluge of supply was well digested, with average oversubscription rates of 3.8x resulting in tight concessions of 2.2 bps, well below the year-to-date average of 3.7 bps. The technical backdrop was supported by a surge of inflows, with $7.5 billion entering the market for the week, a sizeable increase from the year-to-date pace of around $5 billion per week.

High yield corporates also gained,returning 0.25% for the week, but lagged similar-duration Treasuries by -53 bps. Senior loans returned 0.16%. Both asset classes experienced small outflows for the week, of -$48 million and -$38 million for high yield bonds and senior loans, respectively. That marked the sixth straight week of outflows for loan funds, though the magnitude has moderated recently. Issuance remained busy, though not to the same degree as in investment grade markets, with $7.7 billion pricing in high yield and $20 billion in loans.

Emerging markets rallied0.52% for the week, but lagged similar-duration Treasuries by -90 bps. Local markets returned 0.33%. Emerging markets debt had another week of outflows, with -$429 million exiting the market, around 85% from hard currency funds. Meanwhile, the new issuance market reopened with $21.4 billion pricing, mostly from investment grade issuers and the corporate space.

High yield municipal bond issuance is expected to pick up

The municipal bond yield curve lowered last week,Short- and long-term yields both declined -8 bps. New issuance was robust, even with the U.S. holiday. Deals were priced to sell and well received. Fund flows were positive for the tenth consecutive week, although exchange-traded flows were negative at -$17 million. This week’s new issuance is large, and dealers will likely struggle to place such a big calendar.

The municipal market may come under pressure,but should remain relatively stable due to support from the Treasury market. Outsized muni new issuance should continue, but reinvestment money is trending lower, at only $23 billion in September. That amount should easily be spent this week. Muni yields may come under pressure, but the market should attract new investors as the municipal-to-Treasury yield ratio cheapens. Also, short-term rates have declined dramatically, so investors will be pushed further out on the yield curve to reach income objectives.

The North Texas Tollway Authorityissued $1.1 billion revenue bonds, including $451 million first tier bonds (rated Aa2/AA-). The deal included 5.25% coupon bonds maturing in 2044 that came at a yield of 3.59% and traded in the secondary market at 3.56%.

High yield municipal bond yields decreasedon pace with high-grades last week. High yield inflows totaled $350 million last week, bringing the 2024 total to more than $11 billion. This represents more than 50% of all muni fund flows this year. New issuance is expected to pick up between now and the U.S. election. We are tracking at least 12 deals this week across various sectors. American Dream grant revenue bonds (aka sales tax bonds) moved another 6.5 pts higher last week on better demand after payments have resumed on back-dated debt service. Bond prices have risen by nearly 20 pts since the development.

The muni market should attract new investors as the municipal-to-Treasury yield ratio cheapens.

In focus: Muni bonds have offered strong post-election returns

As some investors remain unsure about the impact of the upcoming U.S. presidential election, we looked at average muni bond returns in the one year following the past seven elections.

High yield municipal bonds returned 7.3% on average, outpacing investment grade municipals at 5.6% and 1-3 month U.S. Treasuries at 2.0% over this period.

We anticipate a similar experience this year, as high yield munis should deliver strong performance due to attractive yields and additional duration, which should support total return heading into a declining interest rate environment. Elevated yields, strong fundamentals and a technical environment still offering discounted pricing provides a unique opportunity.

Investors may take advantage of the 8.58% taxable-equivalent yield available ahead of an expected meaningful decline of issuance after the election, providing an attractive entry point to capitalize on technical dynamics keeping yields elevated. While uncertainty surrounds election outcomes and future policy, post-election returns since 1996 have provided positive investor experience. We expect this to continue.