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Weekly Fixed Income Commentary

Softer economic data push Treasury yields lower

Anders Persson
Chief Investment Officer, Head of Global Fixed Income
Daniel J. Close
Head of Municipals
The Treasury Department building

Weekly fixed income update highlights

U.S. Treasury yields fell on softer U.S. economic data, and spread sectors outperformed. The CPI report remained consistent with expectations for U.S. Federal Reserve rate cuts later this year.

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Watchlist

  • The 10-year U.S. Treasury yield last week, and we expect yields to moderate further over the course of this year.
  • Spread sectors 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 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 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 around the world.

High yield corporates and loans see healthy inflows

U.S. Treasury yields fell last week, with the 10- year yield dropping -8 basis points (bps) to 4.42%. After negative total returns in Q1 and in April, the Treasury asset class has now returned 1.66% in May. The movement last week was driven by softer U.S. economic data. The April CPI report showed a modest deceleration in inflation, as expected, with moderation in shelter and other core services. The report remained consistent with market expectations for Fed rate cuts later this year. Separately, retail sales data showed a sharper drop in spending in April, with the headline measure flatlining and the core measure (stripping out volatile elements like energy and cars) contracting. Prior months were revised lower as well, signaling potential downward revisions to Q1 GDP growth and downside risks to expectations for Q2 growth. 

Investment grade corporates rallied, returning 0.68% for the week and beating similar-duration Treasuries by 6 bps. Inflows slowed sharply, with only $330 million entering the asset class versus the year-to-date average of $4.8 billion per week. Supply remained healthy, with almost $30 billion of new issuance pricing, but there was evidence of softer demand in the new issue market. Deals were oversubscribed by an average of 2.8x and new-issue concessions averaged 3.8 bps. These compare unfavorably with year-todate averages of 3.8x oversubscription rates and 3.2 bps concession.

High yield corporates also gained, returning 0.39% for the week and outpacing similar-duration Treasuries by 9 bps. The asset class saw a healthy inflow of $771 million, while loans saw an even larger inflow of $815 million. Senior loans returned 0.16%. New issuance remained active, with $3.4 billion and $23.5 billion pricing in the high yield and loan markets, respectively. Around half of the loan market is trading above par, so issuers are likely to continue repricing to take advantage of the strong market.

Emerging markets outperformed  for the second week in a row, returning 0.77% and beating similarduration Treasuries by 22 bps. The asset class saw an inflow for the first time in a month, with $90 million entering the market, heavily skewed toward hard currency funds. New issuance was more modest than in other asset classes, with only $2.7 billion pricing for the week. That modest calendar was met with strong demand, with oversubscription rates averaging 3.5x, above the recent average.

Muni bond reinvestment money continues to flow 

Municipal bond yields rose slightly last week, except for the long end. Short-term munis ended 2 bps higher while long-term yields declined -1 bps. The new issue calendar was outsized and generally well received. Fund flows turned negative, despite exchange-traded inflows of $91 million. This week’s new issue calendar should be outsized, but priced to sell and well received.

The muni market remains fundamentally sound. Reinvestment money continues, to the tune of nearly $100 billion. ($25 billion in May, $36 billion in June and $37 billion in July). However, issuers are taking advantage of this trend by increasing new issuance. This week’s calendar will be outsized for the third consecutive week at more than $10 billion. The secondary market is also well bid. Institutional money managers continue to sell shorter-duration bonds into the market. However, with $6 trillion in short-term cash in the market, these short bonds are well received.

New York City Transitional Finance Authority issued $1.5 billion tax-exempt bonds (rated Aa1/AAA). The deal was well received initially, but some bonds traded at a discount in the secondary market. For example, 5.25% bonds due in 2051 came at a yield of 3.95% and traded in the secondary market at 3.99%. This is a function of outsized new muni issuance.

High yield municipal funds saw inflows again last week, land demand for traditional high yield muni bonds continues to strengthen. The average yield for the high yield muni index decreased last week, seeing spreads tighten for many bonds other than Puerto Rico and tobacco in response to growing demand. New issuance remains heavily oversubscribed. As the market approaches pending summer technicals, we expect further credit spread compression for the foreseeable future.

Emerging markets saw an inflow for the first time in a month, heavily skewed toward hard currency funds.

In focus: Favorable muni technicals offer opportunity        

Municipal market new issuance tends to be heavier in the spring and fall. Combined with investors selling municipal bonds to offset tax burdens, this presents an attractive investment opportunity – especially in the current elevated yield environment.

Muni bond issuance has totaled more than $156 billion so far this year, a 31% increase year-over-year. We’ve seen $81 billion coming in March and April alone, versus $75 billion in principal and coupon redemptions during this time, for a net positive supply of $6 billion.

Looking ahead to the summer, $123 billion of issuance is expected, compared to $165 billion of principal and coupon redemptions, for a net negative supply of -$42 billion.

While this dynamic is not uncommon, this extreme disparity presents a unique opportunity for investors to put money to work ahead of this trend.

The Bloomberg Municipal Bond Index currently yields 3.63% – 1.43% higher than the 10-year average – which equates to a taxable-equivalent yield of more than 6%.

   
Table of information for U.S. Treasury market, municipal market, yield ratios, and characteristics and returns
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Taxable-equivalent yield is the yield a taxable investment needs to possess (before taxes) for its yield to be equal to that of a tax-free municipal investment. The yields shown are based on the highest individual marginal federal tax rate of 37%, plus the 3.8% Medicare tax on investment income. Individual tax rates may vary. They do not take into account the effects of the federal alternative minimum tax (AMT) or capital gains taxes.

Performance: Bloomberg L.P.
Issuance: The Bond Buyer, 17 May 2024.
Fund flows: Lipper.
New deals: Market Insight, MMA Research, 15 May 2024.

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.

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