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Investing Commentary published on February 13, 2019

January 2019 Market Commentary


  • U.S. Treasury Curve: Rates fell across most of the curve in January, partly due to dovish Fed comments. However, we think strong labor data and above-trend GDP could put upward pressure on Treasuries in the near term.
  • Tax-Exempt Municipal/Treasury Ratios: We think ratios could remain low due to constrained supply and higher taxes that could boost demand for tax-exempt assets.
  • Municipal Market Technicals: Municipal mutual fund flows were constructive in January, with subdued supply of $22 billion, per the Bond Buyer, and year-to-date inflows of $4.8 billion, per Lipper.
  • Corporate Credit Quality: While lower corporate tax rates were a tailwind for corporate earnings in 2018, comparisons could be tougher in 2019.
  • Corporate Supply and Demand: Issuance was $118 billion in January, per Bank of America Merrill Lynch, which is fairly weak, as financial supply fell. In the meantime, we have seen primary market demand remain high, with many new issues met with strong order books.1
  • Securitized Trends: Mortgage-backed securities benefited from the Fed’s statement of patience and the usual January effect on the sector, which drove outperformance of 32 basis points (bps) on an excess return basis2 – the best month since September 2017.


Market Review

Rebound in Risk Assets

In January, data prints continued to show steady economic growth in the U.S. The month saw a healthy rebound in U.S. ISM manufacturing, and labor data was strong. There was a 10bp increase in the participation rate to 63.2 percent, which is the highest since September 2013. Unemployment rose to 4 percent in January from 3.9 percent in December, likely due to the increased participation rate and the government shutdown. January also saw an end to the shutdown, with President Donald Trump and Congress reaching a deal for a three-week continuing resolution.

While the solid U.S. economic data places upward pressure on rates, Treasuries fell in January across most of the curve due to dovish comments from the Fed and still-present risks to global growth.

In its January meeting, the Fed stated that it will remain patient “in light of global economic and financial developments and muted inflation pressures.” The Fed also released a statement on the normalization of its balance sheet, and said that (1) the Fed will maintain “an ample supply of reserves,” and (2) the FOMC can adjust the size and composition of the balance sheet in light of economic developments. The Fed’s comments increased the likelihood of an earlier end to the Fed’s unwind.

In terms of global growth, China’s Caixin/Markit Manufacturing Purchasing Managers' Index (PMI)3 fell to 48.3 in January – the lowest level in three years – from 49.7 in December. Europe’s January PMI survey also fell further; the eurozone PMI registered 50.7 in January—a 66-month low—versus 51.1 in December.4 However, macro policies are becoming more supportive, with China stimulus building and the ECB saying it will stay in wait-and-see mode before making adjustments.

Overall for January, equities had the highest total return after markets shifted back to risk-on posture over the month, followed by high yield corporate bonds, high grade corporate bonds and municipal bonds.5 However, Treasury returns were positive as well, despite outperformance in risk assets. The 2s10s Treasury curve flattened slightly, while the 10s30s steepened 4bps.

Municipal Market Review

Key Theme: Low Ratios

In January, municipal bonds had solid performance, with total return of 76bps by the Bloomberg Barclays Municipal Bond Index. The best performance was in the belly (7- to 10-year range) of the curve, while the 1- to 3-year and 30-year ranges fared worst. The best-performing municipal sectors were Transportation, Leasing and Education, while Housing, Resource Recovery and California bonds underperformed the Index. Quality performance was fairly even across the rating spectrum.

For the month, ratios fell modestly in the 2-, 3-, 5- and 10-year maturities.6 In general, ratios are low – particularly inside of 10 years. The 10-year ratio closed at 82 percent, after falling below 80 percent midmonth. The 30-year ratio ended the month at 100 percent, below the typical threshold for some institutional buyers. The long end of the municipal curve continues to offer more value, due to falling bank demand. The 2s30s municipal curve steepened 13bps to 142bps, continuing the trend of more steepening in the muni curve versus the Treasury curve.

In California, the new governor, Gavin Newsom, released his proposed fiscal year 2020 budget (begins July 1). Broadly, the budget assuaged market concerns that Newsom will completely change the fiscal discipline implemented by former Gov. Jerry Brown. While Newsom’s budget certainly includes some progressive items, the new budget highlighted that over 85 percent of new spending is “one-time” in nature. “One-time” items include $4 billion to eliminate accrued interfund borrowings accumulated over the past few decades, and an extra $4.8 billion for unfunded retirement liabilities. It also incorporates an additional $4.8 billion toward the state’s budget reserves, resulting in projected year-end general fund reserve balances of $18.3 billion in FY19 (12.2 percent of revenues) and $18.5 billion in FY20 (12.5 percent). We note that this is only a spending proposal and there are still uncertainties as to whether the state’s Democratic legislature will agree to Newsom’s fiscal restraint. Furthermore, Newsom’s fiscal stewardship will become substantially more difficult if state tax collections weaken over the next several months.

Overall, technicals remained supportive, with municipal supply modestly higher than in January 2018 (Figure 2), and secondary trading activity lighter. On the demand side, mutual fund flows reversed in January after December outflows; year-to-date, municipal inflows have reached $4.8 billion.7

Corporate Market Review

Strong Comeback for IG Corporates

Investment grade (IG) corporate excess returns had the strongest January since 2009. The Bloomberg Barclays Corporate Index had total return of 2.35 percent and excess return of 1.83 percent. The Index option-adjusted spread fell to 128bps, versus 153bps at the end of December. The best-performing sectors were Energy and Wirelines, while Packaging, Supranationals, Foreign Local Government, Utilities and Building Materials fared worst. Crossover had the best performance, while AA-rated bonds had the worst.

IG corporate spreads benefited from a more dovish Fed, as well as favorable technicals (including lower hedging costs for foreign investors and significant retail inflows into IG). Corporates also benefited from a general improvement in risk assets, a risk-on mood in January and the abating of some market uncertainties. Brexit progress and some abating of European political fears, along with technicals such as supply, momentum and liquidity also helped.

Corporate earnings have held up well, particularly in banks, despite market volatility. Bank management teams were largely positive in earnings calls and did not indicate signs of credit deterioration. In addition, financial supply waned. Financials outperformed nonfinancials over the month.

In terms of credit, as discussed in Risks and Opportunities in Today’s Corporate Bond Market, the leverage cycle could be turning. Fed Flow of Funds data showed a tick lower in nonfinancial corporate leverage growth. Companies involved in recent M&A deals continue to talk about deleveraging. U.S. corporate margins remain robust, partly due to tax reform tailwinds. However, wage inflation has started to pick up, and trade topics are starting to resurface, which could hinder corporates in the near term.

Importantly, while BBBs outperformed other ratings classes on an excess return basis in January, over the prior few months, BBB-rated companies have lagged. This has led to an increase in the BBB/A OAS ratio.

For the month, issuance was $118 billion, up strongly from a paltry $9.1 billion in December 2018, but down 12 percent from $133.3 billion in January 2018. Overall in 2018, bond flows were about flat, with inflows earlier in the year unwound in 4Q18. For January, IG fund flows reversed to $4.9 billion in inflows, ending a record three-month streak of outflows, per Wells Fargo.

Securitized Market Review

UMBS on Investors’ Radar

To start 2019, MBS and ABS had solid performance and positive excess returns.8


In agency MBS, recent media reports have suggested that the Federal Housing Finance Association may move to end government conservatorship of the housing agencies. Reports say that a plan to end conservatorship could come out within weeks. Such a plan could allow Fannie Mae and Freddie Mac to retain earnings and build capital. Currently, the agencies remit all earnings to the Treasury, and have retained only $3 billion in capital. Despite some uncertainty created by this report, MBS spreads were rangebound and ended the month tighter.9 MBS spreads have retraced their wides in November, and ended the month trading at around 77bps. Excess returns were 32bps for the month.

Market focus is also on the uniform MBS (UMBS) planning, as the implementation of UMBS is set for June (see Five Key Themes in the Securitized Market). Bloomberg announced that it plans to create new Freddie Mac cohorts that will accommodate the new issue Freddie UMBS and the converted UMBS. Also, Freddie Mac has started to publish proposed float compensation grids in anticipation of investors exchanging 45-day delay Gold for 55-day delay UMBS Freddie securities. Freddie has committed to compensating investors for the 10 days of payment delay necessitated by moving their pools from 45-day to 55-day securities.

That said, there are some remaining UMBS hurdles, including SIMFA’s vote on TBA trading rules and the operational system’s readiness for launch.


In asset-backed securities (ABS), market sentiment improved in January alongside overall strength in credit. Credit card metrics continued to be solid, but with some normalization from impressively high levels. In bankcard ABS, losses remain low, and for retail cards, the charge-off rate is right around 5.5 percent – only slightly higher than a year ago. However, credit card trust fundamentals have deteriorated on the margin as the consumer balance sheet normalizes and issuers seek to diversify their business mix away from the low-risk convenience users into revolving balances customers.

In autos, negative headlines have resurfaced and weakness continues in the subprime, lease and retail segments, as a glut of supply from cars coming off fleet and a fall in used car values weigh on the sector.

Overall, excess returns were 16bps for January. ABS supply in 2019 is projected to come in around $255 billion, up modestly from $242 billion priced in 2018.


[1] Monthly High Grade Market Review, Bank of America Merrill Lynch, January 2019. New issue supply performance and new issue concession data.

[2] Based on the Bloomberg Barclays U.S. Mortgage Backed Securities Index.

[3] The Caixin China Report on General Manufacturing, February 1, 2019.

[4] IHS Markit. Data collected January 11-23, 2019.

[5] Source: Bloomberg. Proxy for equities is the S&P 500 Index; for high yield corporate bonds, the Bloomberg Barclays U.S. High Yield Index; for investment grade corporate bonds, the Bloomberg Barclays U.S. Investment Grade Index; and for municipal bonds, the Bloomberg Barclays Municipal Bond Index. Comparisons on a total return basis.

[6] Thomson Reuters TM3 Municipal Market Data, as of January 31, 2019.

[7] Lipper fund flows, for the period ending February 6, 2019.

[8] Based on Bloomberg Barclays MBS and ABS indices. 

[9] Bloomberg Barclays MBS Index. 

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