Weekly fixed income commentary | 04/08/2024 (2024)

Weekly fixed income update highlights

• Total returns were negative for Treasuries and most spread sectors.
• Investment grade corporates, MBS, preferreds and emerging markets all outperformed.
• Municipal bond yields increased. New issue supply was $6B and fund inflows were $80M. This week’s new issuance is expected to be $8.3B.

U.S. Treasury yields rose on strong U.S. economic data, and spread sectors generally outperformed. The overall solid data further reduced expectations for near-term U.S. Federal Reserve easing, though markets still price the first rate cut for June.

Watchlist

• The 10-year U.S. Treasury yield rose last week, but we expect yields to decline slightly over the course of the year.
• Spread assets were mixed but generally outperformed 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 remainshealthythanks 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 is 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: Israel,China, Russiaand Iran.

Emerging market debt sees inflows

U.S. Treasury yield srose last weekamid mostly stronger economic data. The 10-year yield ended 20 basis points (bps) higher at 4.40%, a new year-to-date high. 2-year yields moved less sharply, up 13 bps. The strong March jobs report showed a 303,000 increase in employment last month. The unemployment rate also fell -0.1 percentage point to 3.8%. Encouragingly, the net revisions to prior months were positive as well, in contrast to the recent trend of mostly negative revisions. Meanwhile, the ISM manufacturing survey moved into expansionary territory for the first time since 2022, though the parallel services survey surprisingly retreated. Overall, the ISM surveys remain consistent with a slowdown in real GDP growth to around 1.5% this year. The overall strong data further reduced expectations for near-term Fed easing, though markets still price the first rate cut for June.

Investment grade corporates retreated,returning -1.18% for the week, though they outpaced similarduration Treasuries by 7 bps. The asset class enjoyed its 23rd straight weekly inflow, with $6.3 billion entering the asset class for the week. That was an acceleration from the recent pace, which has averaged closer to $5 billion per week. The new issue market remained active, with around $23 billion of new supply for the week, which the market easily digested. Those deals were oversubscribed by around 3.6x, leading to new issue concessions of around 3.7 bps, in line with year-to-date averages.

High yield corporates also weakenedalongside the rise in rates, returning -0.49% for the week. The asset class lagged similar-duration Treasuries by -6 bps. Senior loans returned 0.14%, the 23rd straight week of positive returns. With the strong and prolonged rally in loans, 45% of the market is now trading above par, the highest rate since 2022. Loan market inflows continued, at $689 million, while high yield funds saw outflows of -$259 million. The new issue market remained active, with $5.5 billion and $5.0 billion of supply in the high yield and loan markets, respectively.

Emerging markets returned -0.46% for the week,though they outperformed similar-duration Treasuries by 59 bps, the best performance across major asset classes. Spreads tightened across sovereigns and corporates, led by high yield sovereigns such as Argentina and Pakistan. Inflows returned for only the second week this year, with $190 million into local funds and $58 million into hard currency funds.

Municipal bond is relatively flat, garnering broad interest

Municipal bond yields rose14 bps and 13 bps on the short and long ends of the curve, respectively. The new issue market was priced to sell, and was generally well received. Fund flows were positive, despite exchange-traded fund outflows of -$390 million. This week’s new issue supply should be well received, as portfolio managers continue to require large blocks of bonds to rework portfolios.

The municipal bond sell off was mainly drivenby recent outsized new issuance. Even with the yield increase, muni yields remain rich compared to Treasuries. However, muni yields have risen gradually, and demand remains strong. The muni bond yield curve is relatively flat, garnering tremendous interest in both the short and the long ends. We expect this trend to continue for the foreseeable future.

Anne Arundel Co., Maryland,issued $240 million general obligation bonds (rated Aaa/AAA). Remaining balances traded at a discount. For example, 5% coupon bonds maturing in 2034 were issued at a 2.69% yield and traded at a loss to the underwriter at a higher yield of 2.76 %. This was due to the Treasury bond sell off and because dealers wanted to move inventory.

High yield municipal bond yields rose last week,but by less than high grade munis. This continues the credit spread tightening trend in 2024, narrowing 39 bps to 210 bps currently. Spreads are biased lower by the richness and large market-weighted contributions from tobacco and Puerto Rico. Spread narrowing has been driven by the return of high yield muni fund inflows, with positive flows every week this year totaling $5.5 billion. Supply has also been limited. We are tracking 12 deals pricing this week, offering only $306 million in total par issuance. New issue deals remain routinely oversubscribed, forcing many buyers to compete more aggressively in the secondary market.

45% of the senior loan market is trading above par, the highest rate since 2022.

In focus: IG corporate issuance sets record

Investment grade (IG) first quarter issuance totaled $537 billion, easily outpacing the previous first quarter high of $479 billion set in 2020. This volume is second only to the Covidfueled surge of $716 billion in the second quarter of 2020.

Issuers were driven to the new issue market by the decline in borrowing costs from both spread compression and the overall lower level of interest rates compared to late last year. Despite the record issuance, IG corporate spreads compressed 9 bps to close the quarter at 90 bps due to strong demand. On average, deals were about 4 times oversubscribed with minimal new issue concessions.

Full-year supply forecasts remain materially unchanged, as the 2024 surge of issuance can be attributed to a pull-forward of plans to issue new bonds. We expect the pace of issuance to slow as we move through the remainder of the year. We believe IG corporate technicals will be supportive of valuations as supply normalizes in the face of still-strong demand.