Spreads inched marginally tighter throughout the week. The OAS on the Blomberg Barclays Corporate Index closed Thursday at 88 after closing the week prior at 90. Spreads are near their tightest levels of the year across the board. First quarter earnings season is in full swing now and Thursday was the busiest day yet, with 11% of the S&P 500 having reported on Thursday. Earnings and economic data have been solid with 86% of S&P 500 companies that have reported so far beating estimates, according to data from Refinitiv. Treasury yields are slightly higher so far this week to the tune of 1-2 basis points. Through Thursday, the corporate index had posted a year-to-date total return of -3.70% and an excess return over the same time period of +1.05%.
It was a muted week for the new issue market which is to be expected during the midst of earnings season. Borrowers brought just $12.9bln of new debt during the week and $111 billion for the month of April. The pipeline for issuance is building, however, and the consensus estimate for May issuance is $150 billion. According to data compiled by Bloomberg, $548bln of new debt has been issued year-to-date.
Per data compiled by Wells Fargo, inflows into investment grade credit for the week of April 22-28 were +$5.4bln which brings the year-to-date total to +$142.5bln.
Fund Flows & Issuance: According to a Wells Fargo report, flows week to date were -$0.7 billion and year to date flows stand at -$3.7 billion. New issuance for the week was $7.2 billion and year to date issuance is at $194.7 billion.
(Bloomberg) High Yield Market Highlights
April is set to become the fifth-busiest month for junk-bond issuance by the end of Friday as about $1.6 billion is slated to price. A total of $47.03 billion has been sold so far this month, trailing September 2020’s $47.065 billion for a spot in the top five, according to data compiled by Bloomberg.
This past March was the heaviest ever with almost $60b and January was the fourth-busiest with $52b
Three of the five most active months on record have occurred this year, contributing to the busiest quarter of all-time
Junk bonds are set post the biggest monthly gains since December, with returns of 1.06% month-to-date. This would be the seventh consecutive month of gains and the longest winning streak in more than a year
The riskiest high-yield bracket — CCCs — are on track to post the best monthly returns in the market with 1.2% gains month-to- date. This is the 13th straight month of gains and the longest rallying stretch since September 1992
The broader junk bond index yield closed at 4.03% and spreads were at +293bps, just 3bps away from the 14-year low of +290bps set on April 7
CCC yields were flat at 6.13% and spreads closed at +504bps, just 11bps off the 14-year low of +493bps
(Bloomberg) Biden Musters Early Congress Momentum to Pass Tax-Spend Vision
President Joe Biden is likely to see some version of his $4 trillion economic plan passed in Congress by September or October if he can keep various Democratic factions from splintering the party and continue fending off Republican attempts to paint it as radical.
Biden holds some advantages in pushing for what would be a massive expansion of the government, not the least of which is that the trillions of dollars spent to counter the economic dislocation of the Covid-19 pandemic reset expectations in Congress and among voters about fiscal policy.
Once Biden’s plan is put into legislative text, Democrats can use Senate rules to bypass Republican opposition to most of it.
But the president’s proposals won’t emerge from Congress unscathed, and it’s not yet clear which parts will be left on the cutting room floor or what might be added. There is also the question of whether Congress, with Democrats holding only the narrowest margin of control, sticks to Biden’s two-part vision of a roughly $2.3 trillion tranche focused on infrastructure and manufacturing and $1.8 trillion package focused on education and child care.
The first test will be infrastructure. There is a strong possibility that Congress is able to come together on a smaller, bipartisan measure focused on roads, bridges, transit, water and broadband internet in the coming weeks.
Biden ally Senator Chris Coons of Delaware said trying to strike a deal with Republicans on some portion of Biden’s plan is necessary because there are Democrats who will balk at trying to pass the rest of it on a partisan basis as was done with the $1.9 trillion Covid-relief bill earlier this year.
Negotiating with Republicans is crucial “both for the benefits of bipartisanship on its own and for internal and political reasons,” Coons said.
Negotiations won’t end even if Democrats go it alone on the bigger part of Biden’s plan.
The Senate Democratic caucus spans the gamut from self-described democratic socialist Bernie Sanders, who is already pushing to add an expansion of Medicare to the mix, to Manchin, who is already calling the level of spending “uncomfortable.” Manchin has expressed concern that the tax increases on corporations Biden proposes to pay for his plans could hurt the economy.
In the House, Democrats currently hold only a six vote majority. It will be a challenge to manage the competing interests of the Congressional Progressive Caucus, which is pushing for trillions more in spending to be added to the Biden plans, and moderates who worry about keeping their seats in the 2022 midterms where the GOP will have a redistricting advantage.
In addition, there is a faction of lawmakers from high-tax states threatening to withhold support on any tax-related legislation unless it also repeals the $10,000 cap on deductions for state and local taxes.
The moderate Blue Dog Coalition warned in a Wednesday statement that Democrats must be realistic in crafting the bills and that “messaging bills that cannot pass both chambers do not put people back to work, do not help open small businesses, and do not lower the costs of health care.”
McConnell on Thursday said Biden was dividing the country and warned that changes made without GOP support in Congress could easily be reversed whenever Republicans regain control of Washington.
(Bloomberg) Fed Strengthens View of Economy While Keeping Rates Near Zero
Federal Reserve officials strengthened their assessment of the economy on Wednesday and signaled that risks have diminished while leaving their policy interest rate near zero and maintaining a $120 billion monthly pace of asset purchases.
“Amid progress on vaccinations and strong policy support, indicators of economic activity and employment have strengthened,” the Federal Open Market Committee said in a statement following the conclusion of its two-day policy meeting. “The sectors most adversely affected by the pandemic remain weak but have shown improvement. Inflation has risen, largely reflecting transitory factors.”
The Fed said that “risks to the economic outlook remain,” softening previous language that referred to the pandemic posing “considerable risks.”
Powell and his colleagues met amid growing optimism for the U.S. recovery, helped by widening vaccinations and aggressive monetary and fiscal support.
At the same time, a rise in coronavirus cases in some regions around the world casts a shadow over global growth prospects, giving policy makers reason to remain patient on withdrawing support. Fed officials have also been largely dismissive of inflation risks for the time being, saying a jump in consumer prices last month was distorted by a pandemic-related decline in prices in March 2020.
U.S. central bankers repeated they would not change the pace of bond buying until “substantial further progress” is made on their employment and inflation goals.
Forecasters surveyed by Bloomberg expect the U.S. economy this year to expand at the fastest pace in more than three decades, with the Fed expected to announce in late 2021 that it will start slowing the pace of asset purchases.
Spreads exhibited little movement this week and the spread on the index looks likely to finish unchanged after it is all said and done. The OAS on the Blomberg Barclays Corporate Index closed Thursday at 89 after closing the week prior at 89. Spreads are very near their year-to-date tights across the board. Treasury yields moved lower throughout the week before drifting higher on Friday. As we go to print on Friday, the 10yr Treasury is almost 10 basis points lower from quarter end when it closed at 1.74%. Through Thursday, the corporate index had posted a year-to-date total return of -3.77% and an excess return over the same time period of +1.07%.
Primary market issuance was subdued this week, which is customary in the days following quarter end. Borrowers brought just $17.6bln of new debt. According to data compiled by Bloomberg, $455bln of new debt has been issued year-to-date, with a pace of -22% relative to last year.
Per data compiled by Wells Fargo, inflows into investment grade credit for the week of April 1-7 were +$5.3bln which brings the year-to-date total to +$112.8bln.
It was a challenging first quarter for corporate bonds as rising interest rates were a headwind for performance across the fixed income universe. Investment grade credit spreads were a bright spot, having shown resiliency during the quarter, but tighter spreads could not overcome volatile interest rates. The option adjusted spread (OAS) on the Bloomberg Barclays US Corporate Bond Index compressed 5 basis points during the quarter, opening at 96 and closing at 91. It was only a little more than a year ago when the global pandemic had roiled markets, sending the spread on the index all the way out to 373. The tone has improved substantially since last March and spreads are now tighter than their narrowest levels of last year when the index opened 2020 at an OAS of 93.
Higher Treasuries were the negative driver of performance for credit during the quarter. The 10yr Treasury opened 2021 at 0.91% and was volatile along the way before closing the quarter at 1.74%. This 83 basis point move in the 10yr over such a short time period was too much to overcome for coupon income and spread compression. The Corporate Index posted a total return of -4.65% during the first quarter. This compares to CAM’s gross quarterly total return of -3.50%.
First Quarter Recap
Excess return presents a picture of the performance of credit spread and coupon income, excluding the impact of Treasuries. The sector that posted the best excess returns to start the year was Energy. This should come as no surprise as oil prices were up over 20% during the quarter and Energy was the worst performing sector for the full year 2020. It was ripe for a rally. Packaging was the lone major industry to post a negative excess return during the quarter of just -0.05%. This is in line with the larger theme in the market currently that has made more cyclical sectors in vogue as the pandemic recovery trade was in full force. This has left some more stable and defensive industries as out of favor at the moment. The recovery trade theme has also led to outperformance for riskier BBB-rated credit versus higher quality A-rated credit. BBB-rated credit outperformed A-rated during the quarter to the tune of 85 basis points on a gross total return basis – a significant number to be sure. We will see, as the year plays out, if this reach for yield can sustain its outperformance over a longer time horizon. We believe that some of the move in cyclicals has been overdone and as a result the portfolio is positioned with a more defensive posture than the index.
Investing in a High Rate World
After the corporate index posted a cumulative gain of almost 25% over the previous two years through the end of 2020, most of it on the back of tighter spreads and lower rates, it is fair to expect a pull-back at some point. The current quarter’s performance can almost entirely be defined by Treasuries reclaiming some of the ground that they gave up during the pandemic. Recall that the 10yr Treasury closed as high as 1.88% in the early months of 2020 before falling as low as 0.51% in August of last year and now closing the first quarter of 2021 at 1.74%. But there is more to the story than a higher 10yr Treasury and a closer look at the Treasury curve reveals some more interesting details, particularly the spread between the 5yr and 10yr Treasury. As you can see from the below chart, the 5/10 Treasury curve has steepened substantially over the course of the past year.
CAM consistently positions the portfolio in maturities generally ranging from 5-10 years and there are several reasons that we have structured our investment grade program around this intermediate positioning. First, our customers will know precisely what they are going to get from us in that they can see the exact quantity of each individual company bond that they own and they can count on us to be positioned within a certain maturity band. This allows the client to more effectively manage other portions of their asset allocation accordingly without worrying that we might engage in interest rate speculation or a wholesale change in strategy. The second reason we have settled on this maturity positioning is that it exposes clients to less interest rate risk than the benchmark and far less interest rate risk than if we went further out the curve by purchasing 30yr bonds. We are good at credit work; building customized portfolios, populating them with individual credits based on our analysis of their credit worthiness and reaping those rewards over a 3-5 year time horizon. Our intermediate positioning allows our returns to be driven by credit spread compression and not by our ability to accurately time interest rates. The third and perhaps most important reason that we settled on this intermediate positioning as part of our core strategy has to do with the steepness of both the Treasury curve and the corporate credit curve from 5 to 10 years. Over long time periods this tends to be the steepest portion of both of those curves relative to the curve as a whole.i To provide some context, at quarter end, the 10/30 Treasury curve was 67 basis points; that is, the compensation afforded for selling a 10yr Treasury and buying a 30 year Treasury was an additional 67 basis points in yield, or 3.35bps of yield per year for each year of the 20 year maturity extension. If we compare this to the 5/10 curve at quarter end when that particular curve was 80 basis points, or 16 basis points of extra yield for each of the 5 years between 5 and 10yrs, you can see that the 5/10 curve is significantly more steep than the 10/30 curve. You are extracting much more compensation from selling a 5yr bond and extending to 10yrs than you would get from selling a 10yr bond and moving all the way out to 30 years. Not only is an investor being much better compensated for each additional year from 5/10 but they are taking substantially less interest rate risk by limiting their extension to just 10 years in lieu of 30 years. As you can see from the above chart, the 5/10 curve flattened all the way down to 7 basis points during the worst of the pandemic-related market dislocation but it has since steadily risen, and is now at its highest level since the 3rd quarter of 2014.
To say we are excited about this newfound steepness in the Treasury curve would be an understatement –we are ecstatic, as it allows us to do two things. First, it allows seasoned accounts (those who have been with us at least 3-5 years) to extract attractive compensation by selling their 5yr corporate bonds and using those proceeds to purchase bonds that mature in 8 to 10 years. For those accounts that have been with us for less time or for new accounts it provides an attractive entry point for new money that can take advantage of the roll-down afforded by the steep yield curve. The roll-down to which we refer is the aforementioned 16 basis points per year that a bond was receiving at quarter end for each year that it declined in maturity.
But the bond math doesn’t stop there. On top of the Treasury curve is another curve, the corporate credit curve. Since corporate bonds trade with spread on top of Treasuries they also have their own curve that varies with steepness over time. The shape of the corporate credit curve is more consistently upward sloping than the Treasury curve. Treasury curves, at times, can flatten or even invert. The corporate credit curve on the other hand is almost always upward sloping.ii It only rarely flattens or inverts on a temporary basis during times of extreme market stress or dislocation, and we are happy to take advantage of those fleeting opportunities when they do appear.
As you can see from the chart above, the yield curve for investment grade corporates shares some of the current qualities of the Treasury curve with a pronounced steepness in the belly of the curve and a much flatter slope beyond 10 years. The beauty of these curves is that, even in the unlikely event that Treasuries and credit spreads stay static over the next 5 years we can still generate a positive total return from coupon income and capital appreciation through the roll-down of bonds currently held. Additionally, the steepness afforded by curves currently offers us some protection from rising rates and/or wider credit spreads.
Our proven strategy seeks to provide clients with a transparent separately managed account that provides a return that is good as or better than the Bloomberg Barclays U.S. Corporate Index. We also want to get them there with less volatility through diminished interest rate risk and credit risk along the way. One of the reasons we outperformed the index by 115 basis points during the first quarter was by virtue of our intermediate positioning. Our portfolio ended the quarter with duration of 6.30 while the index had duration of 8.48.
Looking Ahead
Preservation of capital is at the forefront of our strategy so we hate to post a quarter with a negative total return and we know that our investors feel the same way. Thankfully, given the way that bond math works, and especially for investment grade rated credit, such impairments are typically temporary in nature. Take for example a bond that is trading at a discount to par –as time passes and it gets closer to its maturity date, its price gets closer to par, all else being equal. Discount bonds eventually recapture their value as time goes by – it is just a function of the way that the math works. As regular readers know, even in good times after we post a great quarter, we are loath to focus on such short term performance. Investment grade rated corporate credit is at its best when it is treated as a strategic long term allocation that is part of a well-diversified portfolio. In fact, one of the reasons to own this asset class is to aid in that goal of achieving diversification due to its low correlation with other asset classes and its often negative correlation with equities. Bottom line, if an investor is looking for income, diversification and capital preservation as well as a chance to keep up with and/or beat inflation, then investment grade credit is among the ideal asset classes for helping to achieve those goals. After a volatile first quarter we have a guarded optimism and believe there is an attractive opportunity set for our investment philosophy going forward. We thank you for your continued interest and for placing your trust and confidence in us to manage your money.
This information is intended solely to report on investment strategies identified by Cincinnati Asset Management. Opinions and estimates offered constitute our judgment and are subject to change without notice, as are statements of financial market trends, which are based on current market conditions. This material is not intended as an offer or solicitation to buy, hold or sell any financial instrument. Fixed income securities may be sensitive to prevailing interest rates. When rates rise the value generally declines. Past performance is not a guarantee of future results. Gross of advisory fee performance does not reflect the deduction of investment advisory fees. Our advisory fees are disclosed in Form ADV Part 2A. Accounts managed through brokerage firm programs usually will include additional fees. Returns are calculated monthly in U.S. dollars and include reinvestment of dividends and interest. The index is unmanaged and does not take into account fees, expenses, and transaction costs. It is shown for comparative purposes and is based on information generally available to the public from sources believed to be reliable. No representation is made to its accuracy or completeness.
i Federal Reserve Board, June 2006 “The U.S. Treasury Yield Curve: 1961 to the Present” ii Robert C. Merton, May 1974 “On The Pricing of Corporate Debt: The Risk Structure of Interest Rates
In the first quarter of 2021, the Bloomberg Barclays US Corporate High Yield Index (“Index”) return was 0.85% while the CAM High Yield Composite gross total return was -0.01%. The S&P 500 stock index return was 6.17% (including dividends reinvested) over the same period. The 10 year US Treasury rate (“10 year”) had a steady upward move as the rate finished at 1.74%, up 0.83% from the beginning of the quarter. During the quarter, the Index option adjusted spread (“OAS”) tightened 50 basis points moving from 360 basis points to 310 basis points. Each quality segment of the High Yield Market participated in the spread tightening as BB rated securities tightened 38 basis points, B rated securities tightened 46 basis points, and CCC rated securities tightened 110 basis points. Take a look at the chart below from Bloomberg to see a visual of the spread moves in the Index over the past five years. The graph illustrates the speed of the spread move in both directions during 2020 and the continuation of lower spreads in 2021.
The Transportation, Energy, and Other Industrial sectors were the best performers during the quarter, posting returns of 4.44%, 3.60%, and 2.08%, respectively. On the other hand, Utilities, Banking, and Insurance were the worst performing sectors, posting returns of -1.75%, -0.43%, and -0.39%, respectively. At the industry level, oil field services, retail REITs, refining, and airlines all posted the best returns. The oil field services industry posted the highest return (13.00%). The lowest performing industries during the quarter were health insurance, railroads, supermarkets, and wirelines. The health insurance industry posted the lowest return (-1.34%).
The energy sector performance has picked up where last year left off and has continued to be quite positive to start 2021. As can be seen in the chart to the left, the price of crude has continued its upward trajectory during the quarter. Recently, OPEC+ members agreed to start increasing oil production. They are making a bet on a continued economic rebound by deciding to add more than 2 million barrels a day as summer approaches. “Even in those sectors that were badly hit such as airline travel, there are signs of meaningful improvement,” said Saudi Energy Minister Prince Abdulaziz bin Salman.i
During the first quarter, the high yield primary market posted $162.0 billion in issuance. Many companies continued to take advantage of the open new issue market, and the quarter now holds the top spot for the busiest quarter on record. Issuance within Consumer Discretionary was the strongest with approximately 26% of the total during the quarter. Consumer Discretionary has now had the most issuance for the last four consecutive quarters. Over that time frame, Consumer Discretionary has accounted for approximately 25% of the issuance. Communications has accounted for approximately 13% and good enough for second place.
The Federal Reserve maintained the Target Rate to an upper bound of 0.25% at both the January and March meetings. The chart to the left gives a snapshot of how the Fed’s projections have changed for three economic data points. While broad market consensus is also quite upbeat on the economic outlook, market participants have pushed up the 10-year Treasury yield more than triple off the 0.51% low seen in August 2020. In the face of this, the Fed is content to keep a very accommodative posture. Federal Reserve Chair Jerome Powell said in a recent interview, “So, we will — very, very gradually, over time, and with great transparency, when the economy has all but fully recovered — we will be pulling back the support that we provided during emergency times.”ii
Intermediate Treasuries increased 83 basis points over the quarter, as the 10-year Treasury yield was at 0.91% on December 31st, and 1.74% at the end of the first quarter. The 5-year Treasury increased 58 basis points over the quarter, moving from 0.36% on December 31st, to 0.94% at the end of the first quarter. Intermediate term yields more often reflect GDP and expectations for future economic growth and inflation rather than actions taken by the FOMC to adjust the Target Rate. The revised fourth quarter GDP print was 4.3% (quarter over quarter annualized rate). Looking forward, the current consensus view of economists suggests a GDP for 2021 around 5.7% with inflation expectations around 2.4%.iii
Being a more conservative asset manager, Cincinnati Asset Management Inc. does not buy CCC and lower rated securities. This policy generally served our clients well in 2020. However, the lowest rated segment of the market outperformed in the first quarter of 2021. Thus, our higher quality orientation was not optimal during the period. As a result and noted above, our High Yield Composite gross total return did underperform the Index over the first quarter measurement period. With the market staying positive during the first quarter, our cash position remained a drag on overall performance. Additionally, our credit selections within the consumer non-cyclical sector were a drag on performance. Within the energy sector, our higher quality selections were considered a negative to relative performance as the riskiest segment of the sector performed extraordinarily well. Benefiting our performance was our underweight in the utilities sector. Further, our overweight in the transportation sector, and our credit selections within that sector were a positive.
The Bloomberg Barclays US Corporate High Yield Index ended the first quarter with a yield of 4.23%. This yield is up from the new record low of 3.89% reached in mid-February of this year. The market yield is an average that is barbelled by the CCC-rated cohort yielding 6.55% and a BB rated slice yielding 3.40%. Equity volatility, as measured by the Chicago Board Options Exchange Volatility Index (“VIX”), had an average of 23 over the quarter.
For context, the average was 15 over the course of 2019 and 29 for 2020. The first quarter had 4 bond issuers default on their debt. The trailing twelve month default rate was 4.80% with the energy sector accounting for a large amount of the default volume. Excluding the energy sector from the calculation drops the trailing twelve month default rate to 2.55%.iv The current 4.80% default rate is relative to the 3.35%, 6.19%, 5.80%, 6.17% default rates for the first, second, third, and fourth quarters of 2020, respectively. Pre-Covid, fundamentals of high yield companies had been mostly good and with the strong issuance in each of the last four quarters, companies have been doing all they can to bolster their balance sheets. From a technical view, fund flows did turn negative in February and March, and the year-to-date outflow stands at $4.6 billion.v High yield certainly had some volatility in 2020; however, the market did ultimately provide a positive total return. We are of the belief that for clients that have an investment horizon over a complete market cycle, high yield deserves to be considered as part of the portfolio allocation.
The 2020 High Yield Market was definitely one for the history books. The actions by the Treasury and the Federal Reserve no doubt helped to put in a bottom and provide a backstop for the capital markets to begin functioning amid the Covid pandemic. Generally speaking, the market has recovered. Additionally, the economy is projected to have solid growth over the course of 2021 given the trillions of stimulus that has been put into the system. The vaccine rollout continues and according to the CDC, 32% of the US population has received at least one shot. President Biden recently laid out a $2.25 trillion US infrastructure proposal. Headlines of political wrangling are likely to be front and center this year and perhaps provide some market opportunities. Clearly, it is important that we exercise discipline and selectivity in our credit choices moving forward. We are very much on the lookout for any pitfalls as well as opportunities for our clients. We will continue to carefully monitor the market to evaluate that the given compensation for the perceived level of risk remains appropriate on a security by security basis. It is important to focus on credit research and identify bonds of corporations that can withstand economic headwinds and also enjoy improved credit metrics in a stable to improving economy. As always, we will continue our search for value and adjust positions as we uncover compelling situations. Finally, we are very grateful for the trust placed in our team to manage your capital through such a historic time.
This information is intended solely to report on investment strategies identified by Cincinnati Asset Management. Opinions and estimates offered constitute our judgment and are subject to change without notice, as are statements of financial market trends, which are based on current market conditions. This material is not intended as an offer or solicitation to buy, hold or sell any financial instrument. Fixed income securities may be sensitive to prevailing interest rates. When rates rise the value generally declines. Past performance is not a guarantee of future results. Gross of advisory fee performance does not reflect the deduction of investment advisory fees. Our advisory fees are disclosed in Form ADV Part 2A. Accounts managed through brokerage firm programs usually will include additional fees. Returns are calculated monthly in U.S. dollars and include reinvestment of dividends and interest. The index is unmanaged and does not take into account fees, expenses, and transaction costs. It is shown for comparative purposes and is based on information generally available to the public from sources believed to be reliable. No representation is made to its accuracy or completeness.
i Bloomberg April 1, 2021: OPEC+ to Ease Oil Output Cuts in Cautious Bet on Recovery ii Bloomberg March 25, 2021: Powell Says Fed Won’t Stop Until US ‘All But Fully Recovered’
iii Bloomberg April 1, 2021: Economic Forecasts (ECFC) iv JP Morgan April 1,, 2021: “Default Monitor” v Wells Fargo April 2, 2021: “Credit Flows”
Spreads regained some ground this week and are looking to finish several basis points tighter. The OAS on the Blomberg Barclays Corporate Index closed Thursday at 96 after closing the week prior at 98. Treasuries were unusually volatile again, with the 10yr having a range of over 10 basis points during the week. The FOMC played a large part in driving news flow during the week with a rate decision on Wednesday and an announcement on Friday that they would allow some bank regulatory exemptions to expire at month end. On Wednesday, Chairman Powell repeated promises to hold the Fed Funds rate at a low level in an effort to keep the economic recovery moving in the right direction. Additionally the Fed indicated that it would not budge if inflation breached its 2% target during the year, saying it would view pockets of rising prices as transitory in nature. The 10yr Treasury is wrapped around 1.7% as we go to print on Friday afternoon, which is near the highest level of the year. Through Thursday, the corporate index had posted a year-to-date total return of -5.47% and an excess return over the same time period of +0.35%.
Issuance was strong again this week and will total about $30bln when it is all said and done. Not even the opening day of the NCAA Basketball Tournament could stop things, as a couple of issuers are bringing new deals on Friday. According to data compiled by Bloomberg, $383bln of new debt has been issued year-to-date, with a pace of +35% relative to last year.
Per data compiled by Wells Fargo, inflows into investment grade credit for the week of March 11-17 were +$3.6bln which brings the year-to-date total to +$103bln.
Fund Flows & Issuance: According to a Wells Fargo report, flows week to date were -$0.8 billion and year to date flows stand at -$5.6 billion. New issuance for the week was $15.4 billion and year to date issuance is at $129.7 billion.
(Bloomberg) High Yield Market Highlights
Year-to-date U.S. junk-bond returns turned negative for the first time since January, and are set to post a weekly loss after Thursday’s 0.29% decline. It was the biggest one-day drop in three weeks, according to data compiled by Bloomberg. This would mark the fifth consecutive week of losses and the longest stretch of weekly declines since August 2013.
Yields jumped 13bps to close at a 15-week high of 4.57%, the most in three weeks. Spreads were steady, widening by 5bps to +337 as the 5Y UST rose 6bps to 0.86% on Thursday
While yields rose, spreads remained intact and “avoided volatility” as the demand backdrop remained supportive despite concerns about retail outflows, Barclays strategist Brad Rogoff wrote on Friday
“Strong economic growth should allow higher-beta credit to hold its recent outperformance”
As returns turned negative and investors showed some weariness, there was no serious risk aversion as retailer Neiman Marcus is set to price a $1b offering of five-year notes, rated Caa2/CCC+, as soon as today
Proceeds of the deal will be used to repay debt it incurred to exit bankruptcy in September
Junk bonds have come under pressure after pricing more than $40b this month, just about $2b short of making this the busiest March on record. The most active March came in 2017, with $42.165b sold. This year’s first quarter has seen almost $130b of supply, the second-busiest quarter ever
BB yields rose to a four-month high of 3.72% while spreads held firm widening just 3bps when 5Y UST rose 6bps
CCCs, the riskiest tier of junk bonds, also posted a loss of 0.2% on Thursday. Yields rose 19bps to 6.76%
Stock futures rebounded after dropping overnight as the Nasdaq climbed this morning. Oil tried to recover this morning but was heading for the biggest weekly loss since October
(Bloomberg) Powell Faces Tough Campaign to Convince Traders of Fed’s Resolve
The Federal Reserve succeeded in pushing back against market expectations for a rate hike in the next two years, but only partially.
The central bank envisages keeping rates near zero to the end of 2023 despite a significantly brighter assessment of growth and higher inflation over the near term. After the release, traders trimmed some of the more-aggressive positioning they’ve been building for a “lift-off” by earlier in 2023.
But a 25 basis-point hike by the first quarter that year is still reflected in Eurodollar futures, which are priced off Libor and are a decent proxy for future borrowing costs. So traders haven’t exactly brought their views on the timing that much closer to the central bank’s guidance.
“The market will need to be reminded again and again of the Fed’s commitment” to support the recovery, said Anne Mathias, global rates and currencies strategist at Vanguard Group Inc. “If higher yields don’t slow the economy down, don’t upset the stock market, don’t upset risk-taking, then the Fed doesn’t need to push back hard against them,” she said in an interview.
Current rates-market pricing reflects a lingering conviction that the pace of the recovery will spur the Fed to action, earlier than it anticipates, though Chair Jerome Powell reiterated Wednesday that the Fed needs to see “substantial further progress” on its employment and inflation goals before thinking about a hike.
That statement helped short-end rates fall. Seven-year yields remained elevated, however, which suggests positioning for higher interest rates may be building further out the curve. A later rate hike could force the central bank to move faster to tame inflation.
Market gauges of inflation expectations imply some faith in the central bank’s ability to keep it under control. The five-year breakeven rate, which is derived from the difference between yields on Treasuries and their inflation-protected counterparts, is around the highest since 2008, at 2.63%. That compares with a lower 10-year breakeven rate showing price pressures returning to the Fed’s target over the decade.
That chimes with the Fed’s guidance, in Mathias’s view.
“We’re going to see some interim inflation pressure from pent-up spending,” she said. “Net-net, though, the overall secular forces that have kept inflation at bay have not changed.”
Spreads will finish the week comfortably wide of the year-to-date tights that we saw 2 weeks ago. It was a volatile week for rates and spreads and the OAS on the Bloomberg Barclays Corporate Index closed at 92 on Thursday evening after ending the week prior at 90. Treasuries were relatively calm the first two days of the week before inching higher throughout mid-week as Fed Chairman Powell delivered some dovish remarks on Thursday afternoon. The 10yr Treasury, which traded as low as 1.39% on Monday, had risen to 1.57% into the Thursday close. Friday morning saw the release of an employment report that topped expectations, sending the 10yr even higher, up to 1.62%, but the sell off in rates quickly faded and most of Friday afternoon was been spent wrapped around 1.55%. Through Thursday, the corporate index had posted a year-to-date total return of -4.21% and an excess return over the same time period of +0.50%.
The high grade primary market had a huge week as 45 issuers defied volatility bringing more than $65bln in new debt. Next week also looks like it could be a big number as inflows into the investment grade market have created good demand and issuers have been happy to oblige.
Per data compiled by Wells Fargo, inflows into investment grade credit for the week of February 25-March 3 were +$4.9bln which brings the year-to-date total to +$82bln.
As we move forward, it is now all quiet on the Fed front as the blackout period on public comment is now in effect. The Fed meets March 16-17 so the market will have an interesting test over the next 2 weeks as it must interpret data on its own as opposed to parsing Fed-speak.
Spreads continued their slow burn this week, gradually inching tighter. The OAS on the Bloomberg Barclays Corporate Index closed at 88 on Thursday evening after ending the week prior at 92. Treasuries are at their highest levels of the year for the second consecutive week. The 10yr Treasury closed last week at 1.21% and it is trading at 1.35% as we go to print this Friday afternoon. Through Thursday, the corporate index had posted a year-to-date total return of -2.07% and an excess return over the same time period of +0.83%.
The high grade primary market was light during the holiday shortened week with only $14bln in new issuance. Concensus estimates for next week are calling for $30-$40bln in new issuance, according to Bloomberg surveillance.
Per data compiled by Wells Fargo, inflows into investment grade credit for the week of February 11-17 were +$7.6bln which brings the year-to-date total to +$73bln.
Price action in Treasuries the past two weeks has been wrapped around investor views of stimulus and inflation. As vaccinations increase and infections decrease, global economies can be expected to exit their slumber. We think there is a consensus among market participants that inflation is likely to increase throughout 2021 and into 2022 but we are of the view that there is much uncertainty regarding the degree of the relfation trade. There are numerous areas of the economy that could take years to recover while there are some sectors that have already recovered and those that will bounce back even stronger. Are sustainable broad based price increases across the vast majority of the economy possible? Anything is possible, but we would argue that an extraordinarily robust recovery over a short time period is unlikely – but let’s assume this does come to fruition. While the Fed has said it would tolerate temporary inflation above its targeted level, if it were to view this as something more than fleeting, and if it were to view the economy as “overheating” then it could well accelerate the timeline for raising the Fed Funds Rate. A higher Fed Funds Rate typically leads to tighter financial conditions and slowing growth, which would put a brake on any reflation trade. The point is that yes, we think reflation is likely, especially in certain sectors of the economy. But even if the domestic economy were to recover much more quickly than expected, we are skeptical that the Fed will allow significant levels of inflation without Fed Policy intervention.
This information is intended solely to report on investment strategies identified by Cincinnati Asset Management. Opinions and estimates offered constitute our judgment and are subject to change without notice, as are statements of financial market trends, which are based on current market conditions. This material is not intended as an offer or solicitation to buy, hold or sell any financial instrument. Fixed income securities may be sensitive to prevailing interest rates. When rates rise the value generally declines. Past performance is not a guarantee of future results.
Fund Flows & Issuance: According to a Wells Fargo report, flows week to date were -$0.1 billion and year to date flows stand at $1.8 billion. New issuance for the week was $3.0 billion and year to date issuance is at $75.4 billion.
(Bloomberg) High Yield Market Highlights
The U.S. junk bond market is wrapping up the slowest week for issuance this year with just $3 billion of debt sold so far, and no deals as yet slated to price Friday. Average yields, meanwhile, have bounced off all-time lows reached earlier this week.
As new issuance slowed, investors piled billions of dollars into offerings that did come to market even as high-yield funds saw an outflow this week
February issuance volume is running at almost $25b, about $5b away from the total amount sold in the same month last year, according to data compiled by Bloomberg
CCCs, the riskiest junk bonds, have accounted for 25% of bond sales this month. Issuers have ranged from energy firms to covid-hit borrowers from the travel, leisure and entertainment sectors
Average junk bond yields rose 3bps to 3.99% Thursday, but are still just 10bps off the record low set earlier this week
The broader index posted a loss of 0.05% on Thursday, the second consecutive session of negative returns, and the biggest one-day loss in three weeks
(Bloomberg) BB Junk-Bond Yields Drop Below 3% for the First Time Ever
The average yield on U.S. junk bonds in the Double-B tier dropped below 3% for the first time ever on Tuesday as investors continue to pile into an asset class historically known for its high yields.
The average yield on BB debt, the safest of junk bonds, fell 7bps to a record low of 2.98%, according to Bloomberg Barclays index data
The measure for the broader U.S. Corporate High-Yield index dipped to 3.89%, down 7bps in the biggest one-day decline in about seven weeks, the data show
CCC yields also fell to a new low of 6.11% amid calls from some credit strategists to selectively buy the riskiest of junk bonds to boost returns
There is “no reason to be bearish” and cash levels are down to just 3.5%, an eight-year low, Bank of America wrote in the report based on a survey of global fund managers
More borrowers are expected to sell new debt to take advantage of cheap borrowing costs and strong demand from investors
CCC debt has gained 1.19% in February, and 2.69% since the start of the year, beating all other rating buckets in the junk bond market
The broad junk index has gained 1.02% month-to-date and 1.36% year-to-date
The rally may continue with oil closing at a 13-month high near $60as a winter storm halts a third of U.S. crude output
(Wall Street Journal) Saudis Plan to Reverse Oil Cuts as Prices Rise
Saudi Arabia plans to increase its oil output in the coming months, reversing a recent big production cut, advisers to the kingdom said, a sign of growing confidence over an oil-price recovery.
The world’s largest oil exporter surprised oil markets last month when it said it would unilaterally slash 1 million barrels a day of crude production in February and March in an effort to raise prices.
But the kingdom plans to make public a reversal of those cuts when a coalition of oil producers meet next month, the advisers said, in light of the recent recovery in prices. The output rise won’t kick in until April, given the Saudis already have committed to stick to cuts through March.
The advisers cautioned the plans still could be reversed if circumstances change, and the Saudis’ intention hasn’t yet been communicated to the Organization of the Petroleum Exporting Countries, the people and OPEC delegates said.
“We are in a much better place than we were a year ago, but I must warn, once again, against complacency,” Prince Abdulaziz bin Salman, the Saudi energy minister, said at a conference on Wednesday. “The uncertainty is very high, and we have to be extremely cautious.”
“A Saudi increase in production. . .makes perfect sense given the tightness that is starting to emerge in the market,” said Ole Hansen, head of commodity strategy at London-based Saxo Bank. “The market will probably take it quite well.”
The planned Saudi move to restore supplies isn’t expected to immediately spark large output increases from other big producers, analysts said, given the kingdom is acknowledged to have carried the biggest burden in reducing production.
However, analysts do expect compliance with output curbs among producers to be increasingly loose as the recovery gains momentum.
