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Investing Commentary published on September 16, 2019

August 2019 Market Commentary

Summary

  • U.S. Treasury Curve: Yields on the 10-year Treasury dropped over 50 basis points (bps), to 1.50 percent.
  • Tax-Exempt Municipal/Treasury Ratios: The inversion of the 2s5s curve deepened over August; we also saw the 2s10s portion of the Treasury curve invert on August 14.
  • Municipal Market Technicals: The market was more-than equipped to handle the increased supply as municipal mutual fund inflows persisted, with the year-to-date total now at $63 billion.
  • Corporate Market Technicals: Remain strong due to broad-based inflows and declining dealer inventories.
  • Securitized Trends: Prepayment fears due to the sharp drop in rates was the main driver of price action last month.

Market Review

President Donald Trump kicked off a month of volatility in August, escalating the trade war with China on the first day of the month. Within the week, the president followed up the announcement of new tariffs on China with an accusation that China was manipulating its currency. Concerns over a global recession, increased trade tensions between U.S. and China and the risk of a no-deal Brexit all combined to sharply lower interest rates globally. Over the month, yields on the 10-year Treasury dropped over 50bps to 1.50 percent, threatening the all-time low of 1.36 percent. While the inversion of the 2s5s curve deepened over August, we also saw the 2s10s portion of the Treasury curve invert on August 14.

During the Jackson Hole annual symposium, Fed Chairman Jerome Powell noted that the Fed would act as appropriate to maintain the economic expansion as the outlook for global growth “has been deteriorating.” Much of the Fed’s concerns centered around consistently low levels of inflation and the slowdown in business investment due to trade policy uncertainty. Powell spoke at length on tariffs, noting there was “no rulebook” for trade wars.

Municipal Market Review

Municipal yields plummeted over the month, with the 10-year and 30-year AAA falling to 1.22 percent and 1.87 percent respectively, both historic lows. Municipals underperformed the strong Treasury rally and ratios rebounded by 7-10 ratios across the curve. The 1-year-to-4-year portion of the AAA municipal curve inverted in August by 1bps – the first inversion since 2006. However, the slope of the 2-year-to-10-year AAA municipal curve, at 25bps at month end, remains well off its all-time low of 10bps.

August saw $38 billion in new issuance driven by several large deals, per Thomson Reuters. Despite the low rates/ratios, the market was more-than equipped to handle the increased supply, as municipal mutual fund inflows persisted with the year-to-date total now at $63 billion, just $10 billion shy of the record in 2009 – which saw $72 billion of inflows into municipal funds over the course of the entire year, per Lipper/JP Morgan. These positive technicals bolstered municipals and continued their positive performance streak, with the Blomberg Barclays Municipal Index returning 1.58 percent in August, bringing the year-to-date total return to 7.61 percent. Fourteen of the last 16 months have been positive for municipal bond returns. August returns were strongest for lower-quality and longer-maturity bonds.

Credit fundamentals remain relatively stable with low unemployment, stable home prices and replenished reserves. California was upgraded to AA by Fitch, and the state’s returns have outpaced the broader market by 20bps year-to-date (based on BBG/Barclays Index, through 8/16/19 YTD total return for Main Muni Bond Index – 7.61 percent vs. CA index – 7.81 percent).

Corporate Market Review

For the month, investment grade (IG) corporate spreads widened by 12bps, with the Bloomberg Barclays U.S. Investment Grade Corporate Index generating -105bps of excess returns. The best- performing sectors were Office REITS and Airlines while laggards included much of Energy, as well as Metals and Mining. At the ratings level, higher-quality outperformed with AA-rated corporates generating -69bps of excess returns compared to -121bps for BBBs.

Technicals within the corporate market remain strong due to broad-based inflows and declining dealer inventories. Per Wells Fargo, IG funds reported $18 billion of inflows during the month, bringing year-to-date inflows to $198 billion. IG supply for August was $92 billion per Barclays, bringing year-to-date volume to $876 billion, which is slightly behind the same period in 2018. With the big decline in yields, corporate debt issuance has shifted toward refinancing and away from supporting shareholder enhancements and M&A.

Securitized Market Review

Mortgage-backed securities (MBS) had a negative month in August, returning -63bps of excess returns; year-to-date total return stands at 5.53 percent per the Bloomberg Barclays U.S. MBS Index. Prepayment fears due to the sharp drop in rates were the main driver of price action last month. Net supply of MBS continues to run below forecast (based on dealer estimates); however, the recent rate rally has caused the 2019 net organic supply projections to be rewritten as we enter the strong seasonal time of the year for home buying. Additionally, new and existing home sales have been volatile and the figures have been clouded by seasonal and weather-related impacts.

Agency-backed securities (ABS) performance was positive in August, with 15bps of excess return over Treasuries, per the Bloomberg Barclays ABS Index. Net supply for the sector has been healthy at $161 billion and in line with projections of $245 billion for the year; credit card supply notably is running roughly 48 percent lower year-over-year, per Bank of America.

Agency CMBS also posted excess return of -33bps over U.S. Treasuries, per the Bloomberg Barclays Agency CMBS Index. Longer maturities outperformed shorter maturities as a result of stronger carry and longer duration. Year-to-date Agency CMBS net supply totaled $93 billion through end of August, as the sector continues to take market share from the conduit sector, per Bank of America.

 

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