Weekly fixed income commentary | 03/04/2024 (2024)

Weekly fixed income update highlights

• Total returns were positive across the board, including Treasuries, investment grade and high yield corporates, MBS, preferreds, senior loans and emerging markets.
• Municipal bond yields remained essentially unchanged. New issue supply was $7.6B and fund inflows were $72M. This week’s new issuance is expected to be $6.8B.

U.S. Treasury yields fell across the curve as inflation data met expectations. This week, the European Central Bank is scheduled to meet and Fed Chair Powell will testify to Congress. On Friday, the February jobs report is expected to show a hiring slowdown.

Watchlist

• The 10-year U.S. Treasury yield declined last week, and we expect yields to moderate over the course of the year.
• Spread assets generally gained, but lagged the 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 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 markets continue to outperform

U.S. Treasury yields fell last week,with the 10-year yield down -7 basis points (bps) and the 2-year yield down -16 bps. The Personal Consumption Expenditures price index, the Fed’s preferred inflation gauge, showed core prices rising 0.4% month-over-month and 2.8% year-over-year. There had been some fear of another upside surprise, after CPI inflation was hotter than expected earlier in the month, but this did not occur. Fixed income markets rallied in response. This week, the European Central Bank is scheduled to meet, where no change in policy is expected, and Fed Chair Powell will testify to Congress. On Friday, we expect the February jobs report to show a slowdown from January’s blistering pace of 353,000 jobs created.

Investment grade corporates gained,returning 0.22% for the week, though the asset class lagged similar-duration Treasuries by -40 bps. Investment grade funds experienced their 18th straight week of inflows, with $6.5 billion entering the asset class. New issuance remained heavy, with $53 billion for the week, taking February’s total to an all-time record of $197.4 billion. That was around 35% more than expected entering the month, taking this year’s overall supply run rate to 26.5% more than the equivalent period last year.

High yield corporates also rallied,returning 0.20% for the week but underperforming similarduration Treasuries by -22 bps. Senior loans gained 0.23%. High yield funds had outflows of -$449 million, while loan funds had inflows of $408 million. Both asset classes continued to see healthy new issuance, which was well-digested by the market, with $3.4 billion pricing in high yield and $5.1 billion in loans.

Emerging markets continued to perform,returning 0.45% for the week. They lagged similarduration Treasuries by -12 bps, which was still better than other risk asset classes. In hard currency sovereigns, high yield names outperformed again, with spreads compressing by -21 bps, while investment grade sovereigns widened 1 bps. Outflows continued, though the pace decelerated, with -$245 million exiting hard currency funds and -$258 million leaving local currency funds.

Muni bond new issuance calendar should build

Municipal bond yield were basically unchangedlast week.New issuance was well received inflows returned, including exchange-traded fund inflows of $350 million. This week’s new issue calendar should be priced to sell and well received.

Tax-exempt bonds continue to trade rich to their taxable counterparts,but they remain well bid. There is just not enough supply to meet demand. The new issue calendar is building, but March represents the fourth consecutive month with outside reinvestment money to be put to work. The calendar should build, but outsized cash will remain. We may see some weakness come tax time, but soon after that thoughts should turn to the outsized reinvestment income for June and July. We expect Treasuries and muni bonds to remain well bid. We would look at any potential sell off as a buying opportunity.

New York City, New York,issued $1.5 billion general obligation bonds (rated Aa2/AA). The deal was well received, and underwriters were able to lower yields on all but the short end of the curve. For example, 5% coupon bonds due in 2031 came at a yield of 2.69% and traded in the secondary market at 2.68%.

High yield municipal yields continue to decrease on average,resulting in inflows of $400 million last week. Demand is spreading to traditional areas of the high yield muni market in both primary and secondary markets.

Investment grade corporate new issuance remained heavy, taking February’s total to an all-time record.

In focus: Investors prefer preferreds

While fixed income has generally struggled year-to-date, preferred securities are off to a solid start. Their 3.40% total return tops the bond market leaderboard, followed by senior loans (+1.73%) and high yield corporates (+0.47%).

This outperformance has been driven by spread compression, especially in the $25 par preferred sector, due to favorable technical factors. In particular, the segment’s net supply has been negative, and issuers have stepped up call activity. Preferreds have also benefited from strong fundamentals. Banks, which make up the largest percentage of the asset class by issuer, sport healthy underlying credit metrics, as reflected in solid quarterly earnings and encouraging results from the Fed’s 2023 stress tests.

Short-term results aside, we believe preferreds can play a key role in diversified portfolios, as they have demonstrated low correlation to stocks and traditional fixed income sectors while delivering attractive, tax-efficient payouts. And thanks to their fixed-to-floating-rate coupon structures, preferreds typically offer a measure of protection against interest rate volatility.

Because preferreds are a highly inefficient asset class, we believe active management is essential. We suggest strategies that invest across the full credit quality spectrum in both $25 par retail and $1,000 par institutional, in addition to contingent capital (CoCo) securities.