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Weekly Commentary

Treasury yields rise as inflation data climb

Anders Persson
Chief Investment Officer, Head of Global Fixed Income
Daniel J. Close
Head of Municipals
Stone stairs

Weekly fixed income update highlights

U.S. Treasury yields moved higher again last week as inflation moderated less than expected. This caused the market to reduce the number of U.S. Federal Reserve rate cuts expected in 2024 to fewer than four, with the first one anticipated in June.

Watchlist

  • The 10-year U.S. Treasury yield rose last week, but we anticipate declines in overall rates in the months ahead.
  • Spread assets broadly 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: Israel, China, Russia and Iran.

Investment grade corporate spreads match their 2024 low 

U.S. Treasury yields rose last week, as consumer price index (CPI) data showed U.S. inflation moderating less than anticipated. The market expected year-over-year CPI to fall below 3% from 3.4%, but instead it declined to 3.1%. On the heels of the CPI release, Atlanta Federal Reserve President Raphael Bostic asserted that it is not yet clear that inflation is moderating to 2%. The front end of the yield curve rose the most, as the 2-year yield increased 16 basis points (bps) for the week, closing at 4.64%. The market is now pricing in fewer than four Fed rate cuts in 2024, with the first cut anticipated in June.

Investment grade corporates declined, returning -0.45% for the week given the increase in Treasury yields. However, the asset class outperformed similar-duration Treasuries by 21 bps, as spreads narrowed by 3 bps to match the low of 92 bps year-to-date. The asset class saw another week of strong inflows at $5.9 billion, nearly evenly split between mutual funds and exchange-traded funds. The new issue market saw $37 billion in supply, slightly lower than the $40 billion expected. Demand was strong, with average oversubscription rates of 3.7x and new issue concessions of about 1 bps. Supply is up 16% year-to-date compared to the same period in 2023.

High yield corporates also declined, returning -0.32% for the week but narrowly outpacing similarduration Treasuries by 5 bps. The asset class saw outflows of -$89 million, driven by ETF redemptions. Senior loans returned 0.23% for the week, making it the only taxable asset class with positive total returns. The higher-for-longer narrative is positive for the asset class given its floating-rate nature. In contrast to high yield corporates, senior loans saw inflows of $418 million. The new issue market was active, with $7.8 billion and $11.4 billion issued in the high yield and loan markets, respectively.

Emerging markets ended nearly neutral, returning -0.01% for the week and beating similar-duration Treasuries by 58 bps. Spreads compressed in both sovereign and corporate markets, with high yield names once again leading the way. Emerging markets saw fund outflows, led by hard currency funds, after seeing the first inflows in two months the prior week. The new issue market was quiet, with only two deals pricing for a total of $5.5 billion.

High yield muni inflows are boosting performance

Municipal bond yields ended higher last week, with short- and long-term yields rising 3 bps and 2 bps, respectively. The new issue calendar was priced to sell and well received. Fund flows were negative for the second week in a row, and ETF flows were also negative at -$471 million. This week’s new issue calendar should be light due to the U.S. holiday-shortened week.

The muni bond story remains the same: A large amount of cash remains on the sidelines to be reinvested, and supply is tepid. Munis remain rich relative to Treasuries, and this trend should continue as long as muni new issuance remains light.

Humble Independent School District, Texas, issued $146 million general obligation school building bonds (rated AAA/AAA, as they are backed by the permanent school fund). The deal was well received, and some bonds traded in the secondary market at a premium. For example, 4% coupon bonds due in 2054 came at a yield of 4.24% and traded in the secondary market at 4.19%.

The high yield municipal market saw inflows of $214 million last week. Inflows total $1.4 billion year-to-date, despite ETF outflows of -$490 million. Continued inflows and February reinvestment flows have strengthened demand, resulting in the high yield muni market outperforming more volatile fixed income asset classes. New issue deals have been routinely oversubscribed recently. New issuance should be typically light in this holiday week, with only five deals on the calendar. On 16 February, the U.S. Federal Energy Regulatory Commission (FERC) provided conditional approval of the merger and consolidation of Energy Harbor and Vistra assets, allowing the formation of a new company named Vistra Vision.

Investment grade corporate supply is up 16% year-to-date compared to the same period in 2023.

In focus: Warm CPI cools rate cut hopes

Last Tuesday, traders anxiously awaited the outcome of January’s U.S. Consumer Price Index (CPI) readings, looking for signs that progress on inflation would resume after stalling in December. Instead, prices rose more than expected, demonstrating the challenges the Fed faces in taming inflations.

Headline CPI increased 0.3% last month, with food costs rising at their fastest pace in a year. Meanwhile, core CPI, which strips out volatile food and energy prices, popped 0.4% on the strength of a 0.9% rise in the “supercore” gauge (core services ex-shelter) — the Fed’s preferred sub-index — which notched its largest monthly increase in almost two years.

Although this report covered just one month of data, it comes on the heels of January’s blowout job creation. Taken together, they point to a U.S. economy that’s showing few signs of letting up despite the Fed’s aggressive tightening.

Markets reacted sharply to the CPI print. The 2-year Treasury yield, which is highly sensitive to the Fed’s near-term monetary policy outlook, soared 18 bps for the day, to 4.66%, before closing the week at 4.64%.

The market-implied odds of a March rate cut are now near zero, with lower rates in May no longer an odds-on bet. We think six cuts are possible in 2024 if U.S. GDP slows materially in coming quarters, but four are more likely, reflecting our base case for cooler inflation in the near term.


   
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, 16 Feb 2024.
Fund flows: Lipper.
New deals: Market Insight, MMA Research, 14 Feb 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.

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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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This information does not constitute investment research as defined under MiFID.

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