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Weekly Fixed Income Commentary

Treasury yields continue to climb on escalating Fed rhetoric

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

Weekly fixed income update highlights

U.S. Treasury yields rose yet again as the U.S. Federal Reserve (Fed) continued to ratchet up its hawkish tone. We believe Chair Powell will remain focused on inflation until the rate of price increases slows to 2% — the Fed’s target — or close to it.

[Like what you’re reading? Sign up here for Nuveen’s weekly market insights to receive content like this delivered to your inbox every Monday morning.]

Watchlist

Investment views

Accommodative interest rate policy remains a key market support. While investors continue to focus on more hawkish Fed policy, overall rates are likely to remain relatively low even after several rate hikes.

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 rise this year, but the pace of long-term increases should remain relatively modest.

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 new issue market opens up substantially

U.S. Treasury yields moved higher again last week, with the 10-year yield rising 24 basis points (bps) to 3.69% – a new 12-year high. Yields have now increased for eight consecutive weeks, the longest such streak since 1994. The moves were driven by escalating hawkish rhetoric from the U.S. Federal Reserve, as it raised interest rates by another 75 bps and signaled additional outsized hikes are likely later this year. More policy-sensitive 2-year Treasury yields ended the week 33 bps higher.

Investment grade corporates continued to weaken alongside the selloff in Treasuries. The asset class returned -1.61% for the week, underperforming similar-duration Treasuries by -29 bps. Yields touched a fresh 13-year high at 5.43%, but spreads were relatively well-contained and only widened by 4 bps to 146 bps. The primary market was muted, with only around $6 billion of new issuance for the week, versus expectations of around $20 billion. Those new deals came with relatively attractive concessions of around 11 bps.

High yield corporates underperformed amid fundamental and technical headwinds. The asset class returned -1.74% for the week, underperforming similar-duration Treasuries by -63 bps. On the fundamental side, the Fed’s escalating hawkishness raised fresh concerns around rates and the growth outlook. On the technical side, outflows continued at -$1.7 billion. The new issue market opened back up substantially, headlined by the $8 billion Citrix issuance, split roughly evenly between bonds and loans. Leveraged loans also sold off for the week, returning -0.91%.

Emerging markets bonds weakened, returning -1.76% for the week. The strengthening dollar continued to act as a headwind, especially for local currency markets, which underperformed versus hard currency. Separately, the new government in the United Kingdom announced new budget measures that entail substantially more borrowing than previously anticipated. The policies are likely to be inflationary and lead to even higher policy rates from the Bank of England. Two- and 10-year gilt yields rose 82 and 69 bps, the largest weekly increases on record going back to 1989.

Municipal bond new issuance remains muted

Municipal bond yields rose across the board last week. Short-term yields rose 43 bps and longterm rates increased 12 bps. Fund flows were negative for the seventh consecutive week. New issue supply was muted and is expected to be undersized again this week.

The Treasury yield curve is flat and inverted in some areas, suggesting that many investors believe the Fed will show it has inflation contained sooner rather than later. They are betting longer-term bonds – which currently yield less than short-term bonds – will rally once inflation is controlled.

The municipal bond curve is also very flat, suggesting the same thought process. Although munis continue to sell off, they are bid constructively. New issue supply has been muted, easing market pressure. Institutions continue to trade daily to rework portfolios, and individual investors remain interested. We expect heightened volatility through year end, but anticipate a constructive year for fixed income in 2023.

The Board of Water Works of the Louisville/ Jefferson Co. Metro Government  (Kentucky) issued $125 million water system revenue bonds (rated Aaa/AAA). The deal included a 5% bond due in 2032 coming at a yield of 3.16%. The 10-year Treasury bond closed Friday at 3.68 %. These bonds yield 86% of the 10-year, which is considered fair value.

High yield municipal spreads widened 8 bps last week,  (Kentucky) driven largely by tobacco and Puerto Rico, with the market anticipating additional liquidity pressure. Strong secondary market trade volume shows that yields are attracting firm demand. High yield municipal credit spreads are inverted by 43 bps between 7- and 20-year maturities. The new issue calendar remains light, and deals are successful to the extent they satisfy buyer demands in what is firmly a buyers’ market.

Strong high yield muni secondary market trade volume shows that yields are attracting firm demand.

In focus: The Fed’s upward march continues

As expected, last week the Fed raised its target policy range by 75 bps for the third consecutive meeting, to 3.00% – 3.25%. 

Coming into the meeting, markets had priced in about a 20% chance of a 100 bps hike, driven by August’s hotter-than-expected core inflation data. But the Fed opted to keep the pace of hiking constant, perhaps aware of markets’ sensitivity to hawkish policy surprises.

Looking ahead, the Fed’s dot plot shows a slim majority of voting members anticipating at least one more 75 bps move (probably in November), followed by a 50 bps raise in December. Officials also signaled that they do not intend to cut rates materially in 2023, and Chair Jerome Powell used his press conference to caution against premature policy easing.

The potential impact of the Fed’s systematic hawkishness is evident based on its latest set of 2023 forecasts and the first since June. The median projection for GDP growth fell to 1.2% compared to 1.7%, while the unemployment rate is anticipated to rise to 4.4% from 3.9%.

Since Powell has staked a claim as an inflation fighter regardless of the pain raising rates inflict on the economy, we expect he will remain focused on this mission until the rate of price increases slows to 2% — the Fed’s target — or close to it.

Table of information for U.S. Treasury market, municipal market, yield ratios, and characteristics and returns
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Performance: Bloomberg L.P.
Issuance: The Bond Buyer, 23 Sep 2022.
Fund flows: Lipper.
New deals: Market Insight, MMA Research, 21 Sep 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. Past performance is no guarantee of 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.

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