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    Weekly fixed income review: May

    Weekly fixed income review: May

    May 26, 2023 Fixed income
    Week to May 26, 2023
    • Treasury yields rise on debt ceiling concerns and hawkish Fed comments. 10-year Treasuries reach 3.80% after the ninth rise of the last 10 sessions due to two key causes. Firstly, comments made by Federal Open Market Committee members during the week were increasingly hawkish, and markets now expect a 54% chance of a hike in June with the possibility of a July hike at 94%. While on Wednesday, the ratings agency Fitch issued a warning that a lack of a deal on the US debt ceiling negotiations could place the US’s AAA rating under threat. The 10-year real yield closed above 1.5% for the first time since Silicon Valley Bank’s collapse.

    • Business activity in the US reaches a 13-month high in May. An uptick in service sector activity drove a rise in business activity in the US, despite the rising risk of recession, according to the S&P Global PMI’s flash release. This marks the fourth consecutive month that the reading has remained above the 50-point mark. The survey data reflected a resilient labor market with unemployment having fallen to a 53-year low of 3.4%. Weekly initial jobless claims came in at 229k over the week ending May 20 (vs. 245k expected). Retail sales excluding motor vehicles, building materials and food services rebounded strongly, while factory production and homebuilding picked up. Home sales for April stood at 683k, above the 665k estimate, and hit a 13-month high. US Q1 growth was revised upwards to a +1.3% annualized rate (vs. 1.1% previously), whilst core PCE inflation was revised up to +5.0% (vs. +4.9% previously).

    • Eurozone consumer confidence rises in May. Eurozone consumer morale improved marginally to -17.4 in May from April’s -17.5 according to a flash estimate from the European Commission. Elsewhere, revised GDP figures show Germany entered recession in Q1. Gross domestic product fell by 0.3% for the quarter when adjusted for price and calendar effects. This follows a decline of 0.5% in Q4 2022. European yields closed lower on Thursday, before the European Central Bank hinted at further rate hikes, causing yields on 10-year Bunds, OATs and BTPs to all move higher.

    • 10-year UK gilt yields rise to 4.37% on inflation news and Bank of England (BoE) comments. Yields on 2-year gilts also hit their highest levels since September 2022, as inflation figures surprised on the upside. In comments to UK lawmakers, BoE officials indicated that inflation risk remained persistent. Investors predicted a rate hike of 25bp in June, placing the terminal rate at over 4.75%. The UK’s inflation rose to 8.7% in annual terms in April, higher than both market forecasts of 8.2% and the BoE’s anticipated decline of 8.4%, prompting questions about the efficacy of the central bank’s forecasting model. Meanwhile, food price inflation remains near 45-year highs at 19.1% in April, comparable to March’s high of 19.2%. The UK’s flash PMI reflected that services firms reported growth while manufacturing companies shrank. Nevertheless, the indicator remained above 50 points for a fourth consecutive month.

    • The Reserve Bank of New Zealand (RBNZ) raises rates by 25bp. The new rate of 5.5% is the country’s highest in more than 14 years however, the RBNZ signaled it may be done with tightening. The New Zealand dollar slumped more than -1% to a three-week low of $0.617 following the decision.

    • Tax-exempt AAA rated muni yields rise across most of the curve. Except for the 2-year spot, munis underperformed Treasuries. Ratios are now 70% in 2 years, 73% in 5 years, 71% in 10 years and 91% in 30 years. Poor market tone was again pronounced in the 5–10-year segment of the curve while 12–15-year bonds experienced higher demand due to relative yield curve steepness. Trading volumes proved light and FDIC lists continued with approximately 15% of the portfolio transacted thus far. Dealers gained some confidence looking forward to sizeable June 1 reinvestment. Deal reception was tepid except for higher yielding offerings such as NJ Trans CA Aldersly CCRC backed by CA Mortgage Insurance. Weekly reporting muni mutual funds experienced larger outflows of $847 million across all open end categories with ETFs posting modest inflows. Next week’s new issue calendar is approximately $6.0 billion, $5.2 billion taxable and $800 million competitive. Ten-year tax-exempt AAA rated munis are yielding a 2.72% and 10-year taxable munis are yielding around a 4.50%.

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    Source: Bloomberg, May 26, 2023. Prices close of business May 25, 2023.

    Economic calendar

    29 May: Italy non-EU trade balance.
    30 May: Eurozone Consumer Confidence, Economic Sentiment, US housing price index, Japan prelim industrial production.
    31 May: France, Italy GDP Q1, EU financial stability review, US Fed Beige book, Japan consumer confidence.
    01 June: Eurozone prelim HICP, unemployment rate, Swiss trade balance, US initial and continuing jobless claims, US PMI.
    02 June: US unemployment rate.

    Week to May 19, 2023
    • US bond yields rise as debt ceiling deal nears. The initial lack of a resolution in Congress on the government’s debt ceiling saw investors nervous and 1-month Treasury yields rise above 5.5% - a new high this cycle. However, by the end of the week Treasury yields rose and corporate bond yield spreads narrowed on positive comments from both sides in Congress that a compromise would be agreed to allow the debt ceiling to rise.

    • Fed rate rise expectations grow. The New York Empire State Manufacturing Index and retail sales were weaker than expected, while initial jobless claims were stronger. Additionally, Federal Reserve policymakers made generally hawkish statements. Although Atlanta Fed President Raphael Bostic argued that the central bank should pause its tightening to assess the cumulative impact of rate hikes on the US economy, there were plenty of speakers who indicated a more hawkish stance. Richmond Fed President Tom Barkin suggested that the central bank might need to do more to tame inflation, while Chicago Fed President Austan Goolsbee cautioned on service price inflation and said that “it’s far too premature to be talking about rate cuts”. Expectations that the Fed would raise rates again in June climbed to their highest level for about two months.

    • Eurozone bond yields drift higher despite mixed economic data. German, French and Italian 10-year bond yields all rose over the week, with the 10-year bund yield rising above 2.4%, its highest level for nearly a month. Inflation in the eurozone was confirmed at 7% in April. This was a marginal pick-up from March’s 6.9% level, though still in line with expectations. Energy and services-related prices reaccelerated, while food prices eased. After four months of improvement, the eurozone ZEW economic sentiment indicator dropped back into negative territory, with a worse-than-expected reading of -9.4 (down from +6.4 in April) as investors continued to fret about the outlook for the economy and inflation.

    • Bank of England (BoE) concerned at rising wages. Andrew Bailey, Governor of the Bank of England highlighted concern about rising wages and their impact on mid-to-long-term inflation during a speech this week. He talked of the risks of “second-round effects” of wage hikes that follow higher energy and food prices, and that these are in danger of making inflation more persistent in the economy. This is a danger to the central bank’s forecast that headline inflation will more than halve by the year end. However, data published this week shows that average pay (excluding bonuses) rose only from 6.6% to 6.7% in the three months to March, which was less than expected by the market. Adjusted for inflation, wages fell 2%. Gilt yields rose over the week due to Bailey’s comments and hopes of a breakthrough in the US’s debt ceiling negotiations. The 10-year gilt yield hit 4.0%, its highest level since late October.

    • Japanese economy rebounds, inflation rises. After two consecutive quarters that either showed no growth or a mild decline, first-quarter GDP recovered well, growing ahead of expectations by 0.4% quarter on quarter. The rise was driven predominantly by a recovery in consumer spending and private capital expenditure. Government spending and net trade were negative factors, however. Both headline and core (which excludes food but includes energy prices) inflation picked up in April. The former rose to 3.5% from 3.2% in March, while the latter increased to 3.4% from 3.1%. The rise in GDP and inflation will likely keep alive market expectations that the Bank of Japan (BoJ) will ultimately ditch its policy of yield curve control, allowing bond yields to rise. However, BoJ Governor Kazuo Ueda stated overnight that “at present, it’s necessary to continue with monetary easing”, as the domestic economy remains fragile in his view.

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    Source: Bloomberg, May 19, 2023. Prices close of business May 18, 2023.

    Economic calendar

    22 May: Eurozone consumer confidence, PBOC interest rate decision.
    23 May: UK, US and eurozone (flash May) PMIs.
    24 May: UK CPI, PPI and RPI, US FOMC minutes.
    25 May: US initial jobless claims, Germany consumer confidence.
    26 May: UK retail sales, US durable goods orders, US (Michigan) consumer sentiment, US trade balance.

    Week to May 12, 2023
    • Eurozone inflation expectations remain elevated. According to the European Central Bank’s (ECB) Consumer Expectation Survey taken in March, eurozone consumers expect prices to rise by 5% over the next year, compared with 4.6% in the February’s survey. Consumer forecasts for inflation in three years’ time have also risen from 2.4% to 2.9%. The ECB’s Chief Economist, Philip Lane, suggested that inflation was likely to continue to remain entrenched in the eurozone economy over the next few months, owing to higher food prices and the spread of inflation across other categories. However, he backed the ECB’s formal view that inflation would fall by the end of the year. Like, ECB official Isabel Schnabel stated that the central bank needed to do more to bring inflation under control and that rate cuts this year were “highly unlikely”. Despite this, bond yields in the eurozone dropped from mid-week, taking their guide more from the fall in US inflation than rising price expectations closer to home.

    • US inflation falls further in April. The annual rate of headline inflation declined from 5% to 4.9% in April, the lowest level for two years, against a consensus forecast of no change. It was the tenth month in succession that inflation had fallen. Food prices eased, and energy and gasoline prices fell, while shelter or housing inflation moderated for the first time in two years. Meanwhile, core inflation (excluding energy and food costs) fell to 5.5% from 5.6% in April, as expected. Markets took the inflation data well, and bond yields fell. Rate futures also declined, with the December rate falling below 4.5%. Investors and traders are currently discounting no rate increase at the next policy meeting in June, indicating that we are effectively at peak levels now. The growing market expectation that rates will fall in the second half of the year persists despite the Federal Reserve’s insistence that there will be no rate cuts in 2023.

    • The Bank of England (BoE) raises interest rates and UK growth remains positive. The BoE raised interest rates by 25bp to 4.5%, representing the twelfth consecutive interest rate hike by the central bank and leaving headline interest rates at their highest level for fifteen years. Governor Andrew Bailey hinted that further interest rate rises remain possible, stating that the central bank would “stay the course”. The official inflation forecast was revised higher, with the estimate for the end of this year adjusted from 3.9% to 5.1%. Inflation is not expected to return to the official 2% target until the end of 2024.

    • The US semi-annual financial stability report revealed a sanguine view on US banks. The report, published during the week, gave the banking sector a largely clean bill of health, suggesting that it was “well-positioned” to weather difficult economic conditions and any ramifications from the recent turmoil affecting regional banks. The report stated, in general, bank liquidity remains ample and risks limited. Additionally, the report stated the three regional bank failures this year were “outliers” and unlikely to cause wider contagion in the sector. However, the report found that tougher credit conditions in the economy are likely to continue for the foreseeable future, which might cause stress for some highly leveraged institutions.

    • Deflation risks stalk China. China’s consumer price index (CPI) and producer price index (PPI) both eased further in August at a greater pace than expected. The CPI fell to just 0.1% in April on an annual basis from 0.7% in March – the lowest level for over two years – while the PPI fell 3.6% year on year, the weakest figure for nearly three years. Price rises in both food and non-food items have eased considerably, and there are fears that potential deflation within China could lead to lower economic growth.

    • Tax-exempt AAA rated muni yields unchanged; asset class slightly underperforms Treasuries across the curve. This week’s primary calendar received a mixed reception as 7–12-year maturities struggled (curve inversion), 15-year bonds received strong interest and the long end traded by appointment. Dealers cheapened inventories all week looking to move stale bonds. The failed bank taxable muni lists have completed, and the tax-exempt muni bond lists started today with about $60mm of short maturity bonds and pre-refunded bonds receiving strong bids. Weekly reporting muni mutual funds experienced outflows of $102 million, with long-term and high yield funds reporting inflows and intermediate funds outflows. Next week’s new issue calendar is approximately $6.6 billion, $4.8 billion negotiated and $1.8 billion competitive. Ten-year tax-exempt AAA rated munis are yielding around 2.31% and 10-year taxable munis are yielding around 4.20%.

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    Source: Bloomberg, May 12, 2023. Prices close of business May 11, 2023.

    Economic calendar

    15 May: BoE report to Treasury Committee, eurozone industrial production.
    16 May: UK average earnings, UK unemployment, eurozone (Q1) GDP, US retail sales, Japan (Q1) GDP.
    17 May: Eurozone CPI, US housing starts.
    18 May: US initial jobless claims, Japan CPI.
    19 May: Germany PPI, ECB economic bulletin.

    Week to May 05, 2023
    • Federal Reserve raises interest rates as expected. The Fed increased its Fed funds rate by a further 25bp to 5.0% - 5.25%, the highest level for almost 16 years. Fed Chair Jerome Powell said: “we’re closer, or maybe even there” with respect to the peak level of rates. However, he added inflation remained an ongoing worry and that further hikes could not be ruled out and would be considered “meeting by meeting”. The ongoing turmoil in the US banking sector, signs of a slowing in the labor market in terms of reduced job openings and concerns about the fast-approaching deadline for a decision on the government’s debt ceiling caused investors to prefer the relative security of Treasuries. Bond markets took a dovish view on proceedings and the 10-year Treasury yield fell, approaching the 2023 lows of just below 3.3% set in early April.

    • US investment grade bond issuance picks up. There was a flurry of new debt-raising in the investment grade segment of the US corporate bond market, as companies exited their blackout periods following first-quarter earnings reports. Over US $20bn of new debt has been announced from investment grade borrowers in the last few days, led by Meta Platforms and Comcast.

    • US investors sell corporate bonds for Treasuries. As worries about a potential recession in the US and the state of the US regional banking sector have increasingly unsettled investors, there have been signs of a shift from investment grade and high yield issues towards the perceived relative safety of Treasuries. Corporate yield spreads have widened in recent days and weeks, as investors sold issues perceived to be at risk from a deteriorating economic background. Investors also appear to have increased duration overall, viewing the peak in the interest rate cycle as close, with increasing potential for easing ahead.

    • Munis underperform. Tax-exempt munis underperformed Treasuries through to 10-years and outperformed at 30-years. Muni yields fell between 3bp-7bp across the curve, and by more at the short end. This week’s calendar did well with strong oversubscriptions and repricings including the Chicago Water and Wastewater, Energy NW and Columbus Ohio GO issues. This week the SVB/Signature selling of munis commenced. Solely consisting of taxable munis, with maturities 15 years or shorter, the sell lists did well. Pre-paid gas bonds backed by major financial institutions performed strongly this week with significant spread tightening. Weekly reporting muni mutual funds experienced outflows of US$846m as long-term, high yield and intermediate funds all experienced redemptions. The sale of SVB/Signature tax-exempt holdings will begin next week when the new issue calendar is approximately US$7.7bn. The largest deal on the negotiated front is US$1.1bn NY Dorm. Ten-year tax-exempt AAA rated munis are now yielding 2.31% and 10-year taxable munis are yielding around 4.25%. Going forward, we expect the muni market to benefit from strong demand as investors look to reinvest significant bond maturity proceeds and coupon payments June-August.

    • European Central Bank (ECB) raises rates. As widely anticipated by the market, the ECB hiked its benchmark interest rate by 25bp. It marked the seventh hike in succession and took rates to their highest level in almost 15 years. Earlier in the week, the eurozone inflation figure for April came in at 7.0%, compared with 6.9% in March, marking the first uptick in the series since last October. However, core inflation (which excludes energy, food, alcohol and tobacco) eased modestly to 5.6%. Meanwhile, producer price inflation declined to 5.9% in March, down from 13.3% in February and the lowest level for a year, as energy prices eased significantly.

    • UK food price inflation outpaces headline rate. According to figures from the British Retail Consortium (BRC), UK retailers experienced record price rises (dating back to 2005 when its records began) in food of 15.7% year on year in April. This compares with 15% in March.

    • Australia raises rates. The Reserve Bank of Australia unexpectedly raised rates by 25bp to 3.85% – its highest level for 11 years – confounding market expectations. The central bank had paused its tightening cycle in April, stating that it needed some time to assess the effects of past tightening. However, the statement accompanying this month’s hike stated that current inflation of 7% remained too far above the central bank’s target range of 2-3% and needed further action to bring it down and more may follow.

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    Source: Bloomberg, May 05, 2023. Prices close of business May 04, 2023.

    Economic calendar

    08 May: Germany industrial production, Japan BoJ monetary policy meeting minutes.
    09 May: China trade, UK BRC retail sales, UK Halifax house price index.
    10 May: US inflation, Germany inflation (final).
    11 May: UK BoE monetary policy meeting, China inflation, US PPI, initial jobless claims.
    12 May: UK GDP, US Michigan consumer sentiment.

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