- U.S. Treasury Curve: U.S. Treasury rates were broadly lower, particularly in mid to long maturities. The curve inverted in some short- to intermediate segments (See Figure 1).
- Municipal Market Technicals: July issuance was $25 billion, down 32 percent from the prior year. Monthly mutual fund outflows moderated to about $569 million.
- Corporate Market Technicals: Investment grade (IG) fixed-rate bond supply for July was $98 billion. IG bond funds reported $2 billion of outflows during the month.
- Securitized Trends: Mortgage-Backed Securities (MBS) outperformed Treasuries on a total and excess return basis. The broad asset-backed securities (ABS) index also earned a positive total return, while excess returns were negative.
(The following commentary is a summary of discussions among members of the Breckinridge Capital Advisors Investment Committee as they reviewed monthly activity in the markets and investment returns. The members of the Investment Committee under the leadership of Chief Investment Officer Ognjen Sosa, CAIA, FRM, are Co-Head of Portfolio Management, Matthew Buscone; Senior Portfolio Manager Sara Chanda; Co-Head of Research, Nicholas Elfner; Co-Head of Portfolio Management, Jeffrey Glenn, CFA; Head of Municipal Trading, Benjamin Pease; and Co-Head of Research, Adam Stern, JD.)
July offered a welcome respite from the negative returns experienced thus far this year as both equity and fixed income markets rebounded sharply despite negative gross domestic product (GDP) reading for the second consecutive quarter, a 75-basis points (bps) increase in the federal funds rate, continued high inflation measures, and declining consumer confidence.
Responding to weak economic data, Treasuries rallied (See Figure 1). Treasury yields for maturities in the 2-, 5-, 10-, and 30-year ranges were lower by 7, 36, 36, and 17bps, respectively.
As Treasury rates declined, the yield curve inverted. At July 31, the 2-year Treasury yield was 2.89 and the 10-year yield was 2.65 percent.
During July, the S&P 500 Index added 9.1 percent. The Bloomberg U.S. Treasury Bond Index was up 1.59 percent. The Bloomberg U.S. Aggregate Bond Index gained 2.44 percent. Bonds within the Aggregate index with longer maturities and lower credit quality ratings earned higher returns.
At its July meeting, the Federal Open Market Committee hiked the fed funds target rate range to 2.25 percent to 2.50 percent, an increase of 75bps. Still, some commentators considered Chair Powell’s media comments to be more dovish compared with the tone following June’s 75bps increase. The Fed’s own dot plot suggests a median forecast of 3.50 percent for the funds rate by the end of 2022, which would assume another 100bps in hikes, including a projected 50bps increase at the September meeting.
The month ended with a run of downbeat economic data. A 0.9 percent decline in GDP in Q2 followed the 1.6 percent decline in Q1, according to the Bureau of Economic Analysis (BEA). A 14 percent decline in residential investment, according to the U.S. CoreLogic S&P Case-Shiller Index for June included drops in new and pending home. According to the National Association of Realtors, pending home sales declined 8.6 percent from May, as higher mortgage rates and housing prices deterred potential buyers.
The Commerce Department reported weakness in business investment, with an unexpected decline in equipment investment beyond auto and truck shortages. University of Michigan consumer sentiment indicators remain weak, especially on expectations.
While two consecutive quarters of negative GDP changes may technically define a recession, many observers hold that the National Bureau of Economic Research (NBER) is unlikely to call it so given the low level of unemployment, positive payroll growth, and distortions declining inventories and net exports.
The Q2 Employment Cost Index suggested that wage growth continued to run above 5 percent, in contrast to softening in the average hourly earnings figures.
Weaker economic readings also were offset by consumption growth, which slowed to 1.0 percent in Q2 from 1.8 percent in Q1, the BEA reported. Personal income and spending grew 0.6 percent and 1.1 percent in June, respectively, although real spending adjusted for inflation was just 0.1 percent. For June, the Personal Consumption Expenditures (PCE) and Core PCE deflator were in line with consensus at 6.8 percent and 4.8 percent growth year-over-year, respectively
Municipal Market Review
Municipal yields decreased (See Figure 2). Yields fell by 35bps in the 2-year spot and dropped 42, 51, and 29bps, respectively, at 5-, 10-, and 30-year maturities. The curve flattened by 16bps between 2- and 10-year maturities (the 2s/10s curve), while the 2s/30s curve steepened modestly by 6bps.
Municipal bonds outperformed Treasuries and Municipal/Treasury ratios moved lower across the curve, suggesting less attractive relative value for tax-exempt municipals. (See Figure 3).
Municipal bond supply repeated a familiar historical pattern by falling in July. July's total issuance was down 32 percent year-over-year (y/y), according to The Bond Buyer. Issuance of taxable municipal bonds and refunding led the trend lower.
July tax-exempt bond issuance was 20 percent lower than the same month in 2021, while monthly taxable municipal bond issuance was more than 70 percent lower y/y.
Refundings are almost 77 percent lower than last year, as higher yields have eliminated the potential for interest rate savings.
Lower new-issue supply and a decrease in mutual fund outflows helped support the rally in July.
Asset outflows continued from municipal bond funds, but significantly slowed, with two weeks of inflows helping moderate the year-to-date trend. Per Lipper, outflows were $569 million.
The Bloomberg Managed Money Short/Intermediate (1-10) Index surged 2.29 percent and the Bloomberg 1-10 Year Blend Index added 1.92 percent. Longer maturity bonds outperformed shorter maturity issues. Bonds with lower credit quality ratings tended to perform better than higher rated bonds.
With fund flows potentially turning positive and August typically being a net negative supply month, we continue to expect the technical environment to be supportive as the summer closes.
Corporate Market Review
IG corporate bond spreads tightened by 12bps, per Bloomberg data, ending July at 144bps. The Bloomberg U.S. Corporate Investment Grade (IG) Index gained 3.24 percent on a total return basis and delivered an excess return of 1.09 percent compared with duration-matched Treasuries.
The best-performing sectors were railroads, food & beverage, aerospace/defense, restaurants and health insurance. The worst-performing were foreign local government, airlines, supranationals, metals and mining and real estate investment trusts. Lower quality tended to outperform higher quality and longer maturities were favored over shorter maturities.
Index-eligible IG bond issuance in July, per Bloomberg, was $98 billion, $2 billion higher than June’s issuance. Net issuance, after redemptions, was $33 billion. According to Emerging Portfolio Fund Research, IG bond funds reported approximately $2 billion of outflows.
Securitized Market Review
July for mortgage-backed securities was the best month on record in terms of excess returns over duration matched Treasuries, with the Bloomberg MBS Passthroughs Index earning an excess return of 129bps. The notable performance helped to recapture a sizable portion of the cumulative year-to-date underperformance, which stood at 0.48 percent by month-end.
Across the sector, bonds with coupons ranging from 2 percent to 3.5 percent delivered excess returns of greater than 100bps.
Within CMBS, agency-CMBS underperformed while non-agency had a strong month producing 20bps of excess returns.
Within the ABS market, securities backed by credit card debt earned a total return of 82bps and a negative excess return of 5bps, while bonds backed by auto loans earned a total return of 30bps and a negative excess return of 12bps.
This material provides general and/or educational information and should not be construed as a solicitation or offer of Breckinridge services or products or as legal, tax or investment advice. The content is current as of the time of writing or as designated within the material. All information, including the opinions and views of Breckinridge, is subject to change without notice.
Any estimates, targets, and projections are based on Breckinridge research, analysis, and assumptions. No assurances can be made that any such estimate, target or projection will be accurate; actual results may differ substantially.
Past performance is not a guarantee of future results. Breckinridge makes no assurances, warranties or representations that any strategies described herein will meet their investment objectives or incur any profits. Any index results shown are for illustrative purposes and do not represent the performance of any specific investment. Indices are unmanaged and investors cannot directly invest in them. They do not reflect any management, custody, transaction or other expenses, and generally assume reinvestment of dividends, income and capital gains. Performance of indices may be more or less volatile than any investment strategy.
Performance results for Breckinridge’s investment strategies include the reinvestment of interest and any other earnings, but do not reflect any brokerage or trading costs a client would have paid. Results may not reflect the impact that any material market or economic factors would have had on the accounts during the time period. Due to differences in client restrictions, objectives, cash flows, and other such factors, individual client account performance may differ substantially from the performance presented.
All investments involve risk, including loss of principal. Diversification cannot assure a profit or protect against loss. Fixed income investments have varying degrees of credit risk, interest rate risk, default risk, and prepayment and extension risk. In general, bond prices rise when interest rates fall and vice versa. This effect is usually more pronounced for longer-term securities. Income from municipal bonds can be declared taxable because of unfavorable changes in tax laws, adverse interpretations by the IRS or state tax authorities, or noncompliant conduct of a bond issuer.
Breckinridge believes that the assessment of ESG risks, including those associated with climate change, can improve overall risk analysis. When integrating ESG analysis with traditional financial analysis, Breckinridge’s investment team will consider ESG factors but may conclude that other attributes outweigh the ESG considerations when making investment decisions.
There is no guarantee that integrating ESG analysis will improve risk-adjusted returns, lower portfolio volatility over any specific time period, or outperform the broader market or other strategies that do not utilize ESG analysis when selecting investments. The consideration of ESG factors may limit investment opportunities available to a portfolio. In addition, ESG data often lacks standardization, consistency and transparency and for certain companies such data may not be available, complete or accurate.
Breckinridge’s ESG analysis is based on third party data and Breckinridge analysts’ internal analysis. Analysts will review a variety of sources such as corporate sustainability reports, data subscriptions, and research reports to obtain available metrics for internally developed ESG frameworks. Qualitative ESG information is obtained from corporate sustainability reports, engagement discussion with corporate management teams, among others. A high sustainability rating does not mean it will be included in a portfolio, nor does it mean that a bond will provide profits or avoid losses.
Net Zero alignment and classifications are defined by Breckinridge and are subjective in nature. Although our classification methodology is informed by the Net Zero Investment Framework Implementation Guide as outlined by the Institutional Investors Group on Climate Change, it may not align with the methodology or definition used by other companies or advisors. Breckinridge is a member of the Partnership for Carbon Accounting Financials and uses the financed emissions methodology to track, monitor and allocate emissions. These differences should be considered when comparing Net Zero application and strategies.
Targets and goals for Net Zero can change over time and could differ from individual client portfolios. Breckinridge will continue to invest in companies with exposure to fossil fuels; however, we may adjust our exposure to these types of investments based on net zero alignment and classifications over time.
Any specific securities mentioned are for illustrative and example only. They do not necessarily represent actual investments in any client portfolio.
The effectiveness of any tax management strategy is largely dependent on each client’s entire tax and investment profile, including investments made outside of Breckinridge’s advisory services. As such, there is a risk that the strategy used to reduce the tax liability of the client is not the most effective for every client. Breckinridge is not a tax advisor and does not provide personal tax advice. Investors should consult with their tax professionals regarding tax strategies and associated consequences.
Federal and local tax laws can change at any time. These changes can impact tax consequences for investors, who should consult with a tax professional before making any decisions.
The content may contain information taken from unaffiliated third-party sources. Breckinridge believes such information is reliable but does not guarantee its accuracy or completeness. Any third-party websites included in the content has been provided for reference only. Please see the Terms & Conditions page for third party licensing disclaimers.