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Investing

Commentary published on May 5, 2021

April 2021 Market Commentary

Summary

  • U.S. Treasury Curve: Yields trended lower, and the curve flattened. The 10-year and 30-year yields each were 11 basis points (bps) lower.
  • Municipal Market Technicals: Issuance declined from March levels by 27 percent, while demand remained strong.
  • Corporate Market Technicals: Total investment grade (IG) corporate new issuance subsided in April, with $125 billion priced, per Bloomberg. IG fund flows of about $23 billion were down slightly from March.
  • Securitized Trends: Spreads tightened across securitized sectors. Mortgage-backed securities (MBS) were 5bps tighter, while agency commercial MBS (ACMBS) and asset-backed securities (ABS) each were 4bps tighter.

Market Review

Entering 2021, most observers expected investment markets would be influenced primarily by the effectiveness of COVID-19 vaccine distribution and signs of economic recovery. April saw advancements on both fronts.
As of May 1, the Centers for Disease Control and Prevention said about 31% of people in the U.S. have been fully vaccinated.1

Economic readings for the first quarter were also favorable. Per the Conference Board, consumer confidence touched a new one-year high. The Commerce Department reported household income surged 21.2 percent, consumer spending increased 4.2 percent, and first quarter gross domestic product was 6.4 percent on an annualized basis. Initial jobless claims fell to the lowest level since March 2020, the Labor Department said.

In mid-April, the Labor Department said that the Core Consumer Price Index was 2.6 percent higher year-over-year. Services prices, including hotels and transportation, were higher. Core goods were weaker than expected, suggesting limited price pressures from supply chain shortages and bottlenecks, for now at least.

Following its April meeting, the Federal Reserve (Fed) said it will keep rates at near-zero and buy at least $120 billion of bonds per month for the foreseeable future. The Fed indicated that it considers current indications of inflation to be temporary, maintaining that because prices fell at the outset of the pandemic in 2020, 2021 price increases are measuring off a low base.

Across bond markets in April, yields were grinding lower and prices moving higher. With consensus firmly in the higher yield camp, the Street struggled to explain the move lower in yields. Reasons cited included rising Covid variants cases outside the U.S., sluggish global growth, and technical factors.

White House initiatives could benefit municipal credit fundamentals if passed into law. Following March’s announcement of a $2.3 trillion infrastructure plan targeting improvements to roads, bridges, water systems and clean energy, among other sectors, this month the administration revealed the American Families Plan, which includes significant childcare and education subsidies.

For corporate fundamentals, first quarter earnings reports offered good news. FactSet reported on April 30 that more S&P 500 companies are beating earnings per share (EPS) estimates for the first quarter than average, and by a wider margin than average. With 60 percent of S&P 500 companies reporting, 86 percent announced EPS that exceed estimates by nearly 23 percent.

Municipal Market Review

Municipal bond yields declined more than Treasury yields at most spots on the curve (see Figure 1) and municipal bonds outperformed Treasuries for the month.

Municipal bond yields declined 9bps in 5-year and 7-year spots, while yields on the 10- and 30-year maturities fell by 13 and 16bps, respectively. Yield curves were flatter. The 2s10s curve narrowed by 9bps to reach 89bps, while the 5s10s dropped 5bps to 56bps.

Municipal/Treasury (M/T) ratios declined, approaching the low levels of February before recovering somewhat at month end (see Figure 2). After closing March at 54 percent, 64 percent and 72 percent at the 5-, 10- and 30-year maturities, respectively, ratios closed April at 50 percent, 60 percent and 69 percent at those maturities, respectively.

Lower supply and strong demand supported the market (see Figure 3). According to The Bond Buyer, after bouncing above $46 billion during March, new issuance trended lower in April to about $33 billion, which is more typical of the previous five years. Taxable municipal bonds comprised about 22 percent of the total.

Demand was strong. Mutual fund inflows exceeded $8 billion for the month and total more than $41 billion year-to-date, per Lipper.

For March, the Bloomberg Barclays 1-10 Year Blend Index gained 0.48 percent and the Managed Money Short/Intermediate (1-10) Index gained 0.53 percent. Per Barclays, lower-rated bonds outperformed higher-rated bonds. Bonds with longer maturities outperformed shorter maturities.

With demand for tax-exempt bonds high across the curve, we were highly selective when considering newly issued bonds that offered low yields at high prices. We were more active in the secondary market, where opportunities to capture better value relative to new bonds appeared more likely to us. In addition, we looked to leverage our experience in the taxable municipal bond segment of the market to identify favorable investment opportunities. Tax-exempt supply is likely to remain constrained as strong demand persists due to positive credit trends and a potentially higher tax environment.

Corporate Market Review

Based on the BBG IG Corporate Index, corporate bond yield spreads tightened by 3bps. The IG Index gained 1.11 percent on a total return basis and delivered an excess return of 13bps over duration-matched Treasuries.

On an excess return basis, AA-rated bonds outperformed AAA-rated bonds, performed in line with A- and BBB-rated bonds. AAA-rated bond spreads were unchanged on the month, while spreads tightened 2bps for AA-, A- and BBB-rated bonds. On an excess return basis, longer-term maturities underperformed shorter-term bonds.

According to Barclays, the best-performing sectors were REITS, Home Construction, Financials and Metals & Mining. The worst-performing sectors were Tobacco, Health Insurance, Pharmaceuticals, Wirelines, and Cable/Satellite.

Index-eligible IG fixed-rate corporate bond issuance in April per Barclays was $104 billion, down about 43 percent month-over-month. Demand for bonds remained strong. Fund inflows totaled approximately $23 billion, per Wells Fargo.

Corporate earnings are expected to rebound sharply this year, which should drive improved credit metrics across most sectors. We view credit fundamentals as a modest strength for the IG market. While we consider technical conditions to be market neutral, we view valuations as a modest IG market weakness. Spreads are tight by historical standards, although current valuations are in-line with the three-year pre-COVID average.

Securitized Market Review

Securitized products generated positive total and excess returns as spreads continued to grind tighter over the month. Spreads across most sectors remained near multi-year tights. Because timing of prepayment data trails the Fed’s decisions on purchases, Fed purchases of MBS can remain high, even as supply is starting to recede, which can be a supportive market technical.

Per Barclays index data for April, ACMBS earned a 37bps excess return. MBS delivered an excess return of 11bps. Lower coupons led the way as underlying interest rates finished moderately lower. ABS finished with 4bps in excess returns; auto loans and credit cards had excess returns of 3bps and 6bps, respectively.

During the month, the Federal Home Loan Mortgage Corporation (Freddie Mac) announced its first issuance of Green MBS. The bonds support Freddie Mac’s focus on helping borrowers use refinancing proceeds to pay for energy efficiency home improvements, with a goal to preserve home affordability over time. Breckinridge has engaged with Freddie Mac on this topic in recent months, offering our insights and experience with environmental sustainability in the MBS market. The Federal National Mortgage Association (Fannie Mae) issued its first green MBS last April. While MBS Green bond issuance, to date, is limited in pool size and loan amounts, we are keeping an eye on in the future, as we expect more frequent and larger issuances.

 

[1] The New York Times, https://www.nytimes.com/interactive/2020/us/covid-19-vaccine-doses.html?action=click&module=Top%20Stories&pgtype=Homepage, as of May 2, 2021.

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