Commentary May 9, 2017

April 2017 Market Commentary

Market Review

Raindrops Keep Falling on the Fed

Soft April economic data releases have created some headwinds for the Fed as it tries to justify rate normalization. For example, the Consumer Price Index (CPI) fell sharply in March. Additionally, 1Q17 GDP growth was modest at 0.7 percent and the Automotive sector is grappling with weak auto sales, soft used car prices and poor 1Q17 earnings. While March employment data was weak, the Fed did see labor data rebound in April and consumer sentiment remains strong (Figure 1). Total nonfarm payroll employment increased by 211,000 in April and unemployment was little changed, at 4.4 percent.1 

The market’s assigned probability of a June hike has increased to 90 percent, versus 57 percent at the end of March, per Bloomberg. However, the market is now pricing in just one remaining hike in 2017 and two hikes in 2018. In contrast, the Fed is pricing in two more hikes for the rest of 2017.

Treasury yields were rangebound in April despite a brief flight-to-quality trade driven by the French elections, North Korean missile concerns and Syrian turmoil. Disappointing economic data also contributed to Treasury performance. The best performance was in the 5- to 10-year range with yields falling just over 10 basis points (bps), while 3-year and 30-year maturities fell about 5 bps.

Tax-Efficient Market Review

No April Showers of Supply

Municipal bond yields fell in April, with the largest decline in the 4- to 10-year range (down between 10bps to 18bps), and the smallest decline in the 20- to 30-year range (between 3bps and 5bps). Yield volatility reached a 90-day low in April.

Municipal bonds had their fifth straight month of positive returns, with the Barclays Municipal Index returning 64bps.2 Shorter bonds had the lowest returns (16bps-30bps), while 10-year bonds fared best (96bps total return). In contrast to earlier months this year, BBB was not the strongest performer; rather, A-rated bonds performed best, outpacing other categories by a range of 7bps to 16bps. Municipal ratios and relative value were little changed during the month.

Municipal strength in April was mainly driven by low supply, some support from mutual fund inflows and heavy demand from bond maturities being re-invested (Figure 2). Supply was $28.3 billion, down 20 percent from April 2016, and down 12 percent from the start of the year. New money deals rose 32.6 percent versus the same month in 2016, handily outpacing a 50 percent decline in refunding deals.

On the demand side, flows were positive throughout April, although the pace slowed some toward the end of the month because of municipal concerns around President Donald Trump’s new tax plan. Late in the month, the president released a tax plan largely drawing from statements made earlier, including his desire to eliminate individuals’ state and local tax deduction, lower marginal tax rates, reduce corporate taxes and eliminate the alternative minimum tax (listen to our podcast, “Muni Bonds and Trump’s Latest Tax Announcement”).

Credit fundamentals are largely stable, given positive growth in home prices and employment in most parts of the country.

Spreads remain compressed and municipal demand remains robust. As such, we maintained a high-quality bias, allowing us to reduce exposure to some weaker credits.

Government Credit Market Review

All I Can Say Is That My Life Is Pretty Plain

In IG corporates, spreads were rangebound in April, continuing the trend evident in recent months. The Bloomberg Barclays Credit Index tightened 2bps to a spread of 110bps, outperforming duration-matched Treasuries by 19bps.

The best-performing sectors were Midstream, Refining, Paper and Life Insurance, per Barclays. The worst performers included the Foreign Local Government, Supermarket, Automotive and Airlines sectors. In terms of quality, crossover bonds had the strongest performance, while Aa+ credits were weakest.

First quarter earnings have been very solid across several sectors, with strong showings from Energy, Discretionary, Technology and Utilities.3 In addition, the profit outlook has arguably improved given the prospect of meaningful tax reform in the future. However, high gross leverage, a high level of share repurchases and an uptick in M&A deal discussion are all symptoms of late-credit-cycle behavior and are challenging fundamentals. On the other hand, in the U.S. Bank sector, high levels of capital are a positive and earnings remain strong, but some recent deterioration in asset quality—particularly in credit cards and auto loans—is an offset that we are monitoring.

Supply slowed in April to $84.5 billion following extremely high March issuance ($129 billion). The April slowdown was primarily due to a moderation in M&A funding, a rush to issuance at the start of the year in advance of uncertainties later in 2017 and earnings blackout periods. New issuance is expected to return after 1Q17 blackouts, particularly given TLAC requirements4 that are expected to spur issuance. In addition, more M&A announcements have started to hit headlines, such as merger announcements in the TMT space. In that vein, Verizon management said the company was open to merging with companies such as Disney, Comcast or CBS to help counteract weakness in Verizon’s wireless business, per Bloomberg. In the medical technology space, Becton, Dickinson and Company stated that it plans to acquire C. R. Bard Inc. for $24 billion.5

Despite the supply pullback in April, January through April of this year is the record four-month period of investment-grade bond supply, per J.P. Morgan.

From a demand perspective, deals continue to be well-received and fund flows remain supportive. Despite some volatility, IG corporate bond funds reported inflows of $10.2 billion in April, bringing fund inflows to nearly $82 billion year-to-date, per Lipper. Net foreign purchases of U.S. credit remain strong, especially from Europe (Figure 3).6

Strategy and Outlook

Rain or Shine?

Looking forward, we expect Treasury yields to gradually increase and the curve to modestly bear flatten. Risks to our outlook are global instability and political uncertainty, including European elections (Germany and Italy). These elections will provide insight into whether the international populist wave is slowing, which has driven both monetary and fiscal stimulus globally. We are also closely monitoring the dollar, the trajectory of the American Health Care Act following its passage in the House of Representatives and the ability of the Trump administration to push through tax reform.

Also, we are paying close attention to the Fed’s plans for Federal balance sheet reduction. In March, New York Fed President William Dudley indicated that normalization could start either later this year or sometime in 2018. In addition, Fed minutes from the April FOMC meeting imply that most board members agree that it would be appropriate to begin reducing the balance sheet later this year. If the Fed reduces its Treasury/mortgage holdings, this could put upward pressure on mortgage spreads and/or long-term Treasury yields.

Given rate volatility, significant uncertainty in fiscal policy and various potential paths of the U.S. Treasury curve, we remain duration-neutral in our Tax Efficient and Government Credit strategies relative to their benchmarks. Credit and sector allocation remained unchanged in both Tax Efficient and Government Credit portfolios.


[1] Bureau of Labor Statistics, as of May 5, 2017.

[2] Barclays 1-10 Yr Blend (1-12) component of the Municipal Bond Index.

[3] J.P. Morgan, as of May 4, 2017. 

[4] The Financial Stability Board, in consultation with the Basel Committee on Banking Supervision, proposed minimum standards for “total loss-absorbing capacity” (TLAC). The requirements are meant to improve the ability of banks to withstand financial stress and failure without imposing losses on taxpayers.

[5] BD, as of April 23, 2017.

[6] The Fed Treasury International Capital (TIC) System, data for February 2017, released April 2017.

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