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Weekly Fixed Income Commentary

Treasury yields decline on softer economic data

Anders S. Persson
Chief Investment Officer, Head of Nuveen Global Fixed Income
John V. Miller
Head of Municipals
stairs going downwards

Weekly fixed income update highlights

U.S. Treasury yields fell across the curve last week. U.S. economic data was in focus, with producer prices moderating more than expected, lending confidence to the consensus narrative that the U.S. Federal Reserve will soon end its interest rate hiking cycle.

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Investment views

The end to U.S. central bank tightening appears near, as we expect Fed rate hikes to cease early this year. The overall level of rates is likely to remain historically low.

The underlying growth outlook remains healthy, as consumers have strong balance sheets, businesses are reinvesting and Covid recedes. This should keep defaults low.

Treasury yields are likely to fall this year, and we expect the 10-year Treasury yield to end the year around 3.25%.

We favor a risk-on stance, focused on credits with durable free cash flow and solid balance sheets across a wide range of sectors. Mid-quality rating segments appear particularly attractive. Essential service municipal bonds also look compelling.

Key risks

High yield corporate returns soften slightly 

U.S. Treasury yields fell again, with 10-year yields down -2 basis points (bps) to touch a fresh 4-month low. Two-year yields fell -6 bps. Macroeconomic data were in focus, with producer prices moderating more than expected, lending more confidence to the growing consensus that the U.S. Federal Reserve will soon end its interest rate hiking cycle. However, other economic data pointed to a sharper slowdown in activity, with retail sales and industrial production both disappointing to the downside.

Investment grade corporates traded close to flat, as a strong start to the week faded after the weaker macroeconomic data. The asset class returned 0.09% for the week, lagging Treasuries by around 1 bps. Investment grade corporate fund inflows totaled $3.8 billion, while the new issue market calmed somewhat after a frenetic start to the year. Only five issuers came to the market with less than $15 billion of supply, well below expectations for around $25 billion. That led deals to be comfortably oversubscribed, offering just 5.7 bps of concession on average.

High yield corporates softened after a strong start to the year, returning -0.31% and underperforming similar-duration Treasuries by -52 bps. The new issue market picked up, with almost $7 billion of new supply hitting the market. Demand was more tempered, and one deal was pulled due to lack of interest. Loans returned 0.37%, the asset class’s sixth consecutive weekly gain.

Emerging markets outperformed substantially, returning 0.81% and beating similar-duration Treasuries by 67 bps. Within both sovereign and corporate spaces, high yield outperformed investment grade. Inflows into hard-currency funds accelerated further, with $1.9 billion entering the asset class for the week, the biggest weekly inflow since June 2021.

Municipal bonds enjoy second consecutive week of inflows 

The municipal bond yield curve rallied again last week, along with the Treasury curve. Weekly new issue supply was well received and fund flows were positive for the second consecutive week.

Economic data continue to show that inflation is weakening,  yet the Fed maintains it will raise rates to a terminal rate of around 5%. Ironically, this has led to a solid tone for fixed income markets. Some feel fixed income is in a win-win situation. If inflation persists, the Fed will likely stick to its guns and ultimately win the battle with a 5% rate, making it hard to finance further expansion. However, if the economy continues to slow, the Fed will need to stop raising rates, in which case longer-term bonds should rally. Tax-exempt bonds continue to remain well bid. Supply remains muted with an abundant amount of money seeking to be invested. 

The Louisiana Public Facilities Authority (for Tulane University) issued $162 million revenue bonds (rated A1/A+). It was well received. For example, 5% coupon bonds due in 2033 came at a yield of 2.69%. The underwriter quoted a premium bid for any maturity once the bonds were free to trade.

High yield municipal bonds outperformed again last week, as yields decreased and credit spreads tightened on average. Fund inflows were solid last week at $823 million, bringing the two-week total to more than $1.7 billion. SIFMA (short-term money market rate) has reset at 1.86%, a strong affirmation of the return of liquidity to the market. New issue supply this week should again be very light, and we expect the secondary market to be well bid.

Investment grade corporate fund inflows totaled $3.8 billion, while the new issue market calmed somewhat after a frenetic start to the year.

In focus: Odds of U.S. recession grow

With last week’s softer economic data, concern about a possible U.S. recession this year is increasing. Consensus places the odds at around 65%. Whether a recession actually occurs will definitely affect fixed income valuations. The question is especially thorny in the current environment, because different indicators are sending different signals. 

Our recession probability models reflect this uncertainty. For example, a model based on the Treasury yield curve suggests around 60% odds of recession, close to consensus. Our models based on leading economic indicators and surveys of bank lending conditions point to higher odds, around 75%. Measures based on the labor market, where the incoming data have been strong, point to much lower risk, around 25%.

Ultimately, we believe a holistic view is best. Surveying the performance of our models over the last 70 years, it is very rare for all indicators to simultaneously signal high recession risks. Some degree of noise is inevitable. That said, when the average implied recession odds across all of our models is above 50%, as it currently is, a recession has occurred every time.

We believe the odds of a recession look elevated for 2023. We think the depth of a recession would be mild by historical standards, and there should be scope for fixed income investors to selectively and opportunistically add exposure to core sectors, which will likely perform well in the type of mild slowdown that we expect.

Table of information for U.S. Treasury market, municipal market, yield ratios, and characteristics and returns
Performance: Bloomberg L.P.
Issuance: The Bond Buyer, 20 Jan 2022.
Fund flows: Lipper.
New deals: Market Insight, MMA Research, 18 Jan 2022.

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 provides investment advisory solutions through its investment specialists.

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