Stronger jobs data push Treasury yields higher

Weekly fixed income update highlights

• Senior loans was the only sector with positive total returns.
• Treasuries, investment grade and high yield corporates, MBS, taxable munis, preferreds, and emerging markets all had negative total returns.
• Municipal bond yields rose. New issue supply was $10B, and fund inflows were $1.9B. This week's new issuance again totals $10B.

The U.S. Treasury yield curve bear flattened last week, with longer yields rising less than short yields. Stronger-than-expected U.S. employment data led markets to moderate expectations for U.S. Federal Reserve rate cuts for the remainder of 2024.

Watchlist

• 10-year U.S. Treasury yield rose last week in response to stronger U.S. employment data.
• Spread sector returns outperformed Treasuries.
• Increased seasonal supply should provide an attractive entry point for municipal bonds.

Investment views

Rates have peaked for this cycle, and attention has pivoted toward the pace and size of 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 remains 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 corporate inflows see a boost

U.S. Treasury yields rose across the curve last week, led by the 2-year rising 36 basis points (bps). The Treasury yield curve flattened as yields on longer-maturity Treasuries increased by less. Early in the week, Treasury yields declined in response to escalating tensions in the Middle East. However, stronger-than-expected ISM and employment data pushed yields higher later in the week. The September job report showed that the unemployment rate declined to 4.1%, and more jobs were added than expected. In response, the market forecast for additional Fed rate cuts in 2024 moderated from 75 bps to 50 bps.

Investment grade corporates suffered, returning -1.03% for the week but beating similar-duration Treasuries by 43 bps. Spreads declined to 83 bps, the tightest level since September 2021. Despite the strong relative performance, inflows slowed to $7 billion, substantially below the 4-week average of $47.5 billion. New issuance was lower than expected, with just $15.5 billion pricing. Issuance is expected to be light again this week as issuers enter earnings blackout windows.

High yield corporates declined as well, returning -0.15% but outpacing similar-duration Treasuries by 63 bps. Senior loans returned 0.23%, making it the only taxable fixed income asset class to post a positive total return. New issuance was healthy, with $8.5 billion pricing in high yield and $14.2 billion in loans. New issuance activity is expected to wind down over the next few weeks, with a pause ahead of potential U.S. election-related volatility. Meanwhile, high yield funds saw inflows of $2.2 billion, the second largest week for inflows in four months. Loan fund inflows totaled $55 million.

Emerging markets also declined, returning -1.75% for the week but marginally outperforming similar-duration Treasuries by 8 bps. High yield sovereigns and corporates outperformed as spreads of below investment grade segments tightened more than their investment grade counterparts. New issuance remained steady with $10.3 billion pricing, led by emerging markets corporates. Retail inflows slowed to $539 million, led by local currency.

Muni bond new issuance begins to lighten

The municipal bond yield curve ended last week higher, with short- and long-term yields rising 6 bps and 5 bps, respectively. New issuance was priced to sell, and deals were well received. Weekly fund flows were positive for the 14th straight week. This week's new issue calendar should again be priced to sell and well received.

The municipal market outperformed U.S. Treasuries last week. One reason is that muni new issue supply is beginning to lighten, and this trend should continue until after the U.S. election. Meanwhile, strong demand remains for tax-exempt income, with year-to-date inflows of $15.9 billion. We expect Treasury yields to remain range bound, with the Fed continuing to cut rates. This Treasury bullishness should follow through to munis, and we think lower muni new issuance toward the end of the year should provide an extra boost.

Pennsylvania Turnpike Commission sold $585 million revenue bonds (rated A2/A+). The deal was priced to sell and well received. For example, 5% coupon bonds due in 2035 came at a yield of 3.07%. Those bonds traded at a slight premium of 3.04% in the secondary market.

High yield municipal bonds outperformed last week, as average yields increased just 2 bps. Demand continues to grow, with inflows of $600 million last week. The high yield muni market returned 3.21% in the third quarter, as demand consistently applied downward pressure on credit spreads even with an increase in supply. Secondary market trading volume for tobacco bonds has surged due to the supply/ demand imbalance and market access challenges. We are covering another healthy week of new issue deals and expect to see numerous deals to start the quarter ahead of the U.S. election.

Muni bonds should see a boost from lower new issuance toward the end of the year.

In focus: The GIC lays out the fixed income landscape

In its 2024 fourth quarter outlook, Nuveen's Global Investment Committee (GIC), which brings together the most senior investors across our core and specialist capabilities, highlighted some of our best bond ideas.

In our view, both the macroeconomic backdrop and market fundamentals favor fixed income investments. Inflation continues to cool slowly across most areas of the world, and the Fed finally joined other central banks in lowering rates, providing tailwinds for the global bond market. Yields should fall modestly over the course of 2025, according to the GIC.

Markets have mostly priced in rate declines, which we believe argues against lengthening duration, with two broad exceptions: investors sitting on high levels of cash and those holding municipal bonds. The muni bond curve remains steeper than the U.S. Treasury curve, providing the potential for current income and capital appreciation if and when rates drop.

On the taxable side, we view floating-rate debt as less attractive than fixed rate, with a nod toward higher-quality (BB/B) high yield corporates, which still offer relatively healthy yields. This segment should hold up relatively well if the economy decelerates, which the GIC expects. Securitized assets are another favored asset class - asset-backed and commercial mortgage-backed securities, in particular, are attractively valued.

Public link

Please use the above public link if you want to share this noodl on another website.