(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; Head of Municipal Trading, Sara Chanda; Co-Head of Research, Nicholas Elfner; Co-Head of Portfolio Management, Jeffrey Glenn, CFA; and Co-Head of Research, Adam Stern, JD.)

Market Review

With the debt ceiling debate resolved and the Fed choosing to pause interest rate hikes at its June meeting, front-end Treasury yields moved sharply higher, while longer term yields were unchanged and T-bill yields were mostly lower.

Bond market volatility during June touched lower levels not seen since earlier this year, as measured by the Bank of America Merrill Lynch (BofA/ML) MOVE Index¹ and trended modestly higher toward month end (See Figure 2).

While conditions did little to clarify the course ahead for inflation and the economy, overall consumer and market sentiment was resilient, as many appeared to settle in for what may be the status quo for some time to come.

On the economic front, retail sales surpassed expectations. Durable goods orders increased. May saw improvements in housing including starts, building permits, and existing home sales. After accelerating in April, May personal consumption expenditures (PCE) core price pressures softened to 0.3 percent month-over-month (M/M), although core goods inflation registered another strong increase, in line with consumer price index (CPI) data, which held firm. The annual PCE rate fell to 3.8 percent from 4.3 percent in April, as higher energy prices a year ago drove the 2022 reading. 

May readings indicated the inflation pressures from employment and wage growth persisted. Employment was strong on sustained labor demand, although the unemployment rate was up to 3.7 percent, suggesting some easing. The Atlanta Fed’s wage tracker index jumped after falling in April. Personal income was up 0.4 percent M/M, with a 0.1 percent M/M increase in consumer spending. At the end of June, the Bureau of Economic Analysis adjusted first quarter gross domestic product (GDP) up to 2 percent quarter-over-quarter (Q/Q), 0.7 percent higher than its second reading.

The mix of news and forward-looking projections left some market participants wondering where the Fed might go next, as it continues to address inflation that remains above its 2 percent long-term target. By the end of the first half of 2023, certain commentators were predicting at least one more fed funds increase 2023 and few, if any, rate cuts in 2024.

Treasury bond yields increased at every spot along the curve except the 30-year maturity. The 2-year added 49 basis points (bps), according to data from the U.S. Department of the Treasury. The 5-year was 40bps higher and the 10-year was up 19bps. The yield gap between 2-year Treasuries and those with 10 and 30 year maturities each widened.

The Bloomberg (BBG) U.S. Treasury Bond Index² declined 0.75 percent. The BBG U.S. Aggregate Bond Index³ fell 0.36 percent.

Municipal Market Review 

Municipal bond yields declined (See Figure 3), in contrast to Treasury increases. Two-year yields were lower by 15bps, 5-years by 14bps, and 10-years and 30-years by 9bps and 6bps, respectively, per Municipal Markets Data (MMD). 

As municipal bonds prices outperformed Treasuries, Muni/Treasury (M/T) yield ratios fell at June 30 from the YTD highs seen at the end of May. Ratios were 60 at 2 years, 62 at 3 years, 63 and 67 at 5 and 10 years, respectively, and 90 at 30 years, per MMD and the U.S. Treasury Department (See Figure 4).

The BBG Managed Money Short/Intermediate (1-10) Index⁴ gained 0.74 percent and the BBG 1-10 Year Municipal Bond Blended Index⁵ was 0.67 percent higher in June. Generally, longer-maturity bonds outperformed shorter-maturities. Bonds rated A outperformed bonds rated AAA and AA. For the quarter ended and YTD through June 30, the BBG Managed Money Short/Intermediate (1-10) Index fell 1.08 percent and gained 1.12, respectively, while the BBG 1-10 Year Municipal Bond Blended Index fell 0.53 percent and added 1.45 percent.

The Bond Buyer reported that total issuance for June was $34 billion, down 9 percent from $38 billion a year earlier. Total YTD issuance was 20 percent lower than the same period of 2022, at about $175 billion. In June, tax-exempt municipal bond issuance was about 8 percent lower year-over-year (Y/Y), at almost $31 billion. While taxable municipal bond issuance remained well off 2022 levels, down 44 percent Y/Y, total June issuance was $2.8 billion, or 141 percent, more than May. Lipper/Refinitiv reported net municipal bond mutual fund inflows of about $850 million in June, with outflows YTD totaling approximately $8 billion.

Corporate Market Review

Investment grade (IG) corporate bond spreads tightened 15bps tighter, per BBG data, to close June at an option-adjusted spread of 123bps. For the month, bonds rated BBB outperformed higher-quality corporates on a total and excess return bases. Bonds rated AAA were the best performers through the first six months of 2023. Longer-term bonds outperformed shorter maturities for the June and YTD periods.

For the period ended June 30, the BBG U.S. Corporate Investment Grade (IG) Index⁶ earned monthly, quarterly, and YTD total returns of 0.41 percent, negative 0.29 percent, and 3.21 percent, respectively. Excess returns compared with duration-matched Treasuries were 1.22, 1.40, and 1.56, respectively, for the same period. Per BBG, the best-performing sectors and subsectors in June were Cable Satellite, Media Entertainment, Oil Field Services, Life Insurance, and Tobacco. Among the worst-performing sectors and subsectors were Construction Machinery, Consumer Products, Automotive, and Electric Utilities. 

For the first quarter of 2023, corporate bond issuers among the S&P 500 companies reported a 1.6 percent Y/Y decline in earnings, following a 3.4 percent decrease during the fourth quarter of 2022. 

In the Banking subsector, higher funding costs may reduce lending margins and impact profitability. Commercial real estate (CRE) is an area of increased focus, with higher rates and lower occupancy weighing on property valuations and loan performance.

Regional bank spreads have tightened about 50bps from wide spreads seen in May. In our view, a substantial valuation gap remains between regional banks, money center banks and non-financial issuers. 

Fixed-rate, gross investment grade supply for June was about $107.6 billion, BBG reported, with net issuance of $51.8 billion after $55.8 billion in redemptions. About $8 billion in assets flowed onto IG bond mutual funds in June, per EPFR Global.

Securitized Market Review

Across securitized sectors, MBS, CMBS (including Agency and Non-Agency Commercial MBS), and ABS bonds had negative total returns for June, while YTD total returns and monthly and YTD excess return were positive through June 30 with one exception. The exception was a negative YTD excess return for Non-Agency CMBS.

The most favorable MBS excess returns were among 3.5, 4, 4.5, and 6 percent coupon conventional¹⁰ and Ginnie Mae¹¹ securities. 

Equity Market Review

Stock market indices moved higher and the Chicago Board Options Exchange (BoE) Volatility Index¹² (VIX) showed lower equity market volatility (See Figure 5).

The S&P 500 Index¹³ was up 6.5 percent for the month, 8.3 percent for the quarter, and 15.9 percent YTD. Comparable numbers for the Dow Jones Industrial Average¹⁴ were 4.6 percent, 3.4 percent, and 3.8 percent. The NASDAQ Composite Index¹⁵ closed June 6.6 percent higher, the second quarter up 3.4 percent, and the first half of 2023 ahead 3.8 percent.

[1] The Bank of America Merrill Lynch MOVE Index measures U.S. interest rate volatility by tracking the movement in U.S. Treasury yield volatility implied by current prices of one-month over-the-counter options on 2-year, 5-year, 10-year and 30-year Treasuries. Historically, the index rises as concerns grow that interest rates are moving higher. You cannot invest directly in an index.

[2] The Bloomberg U.S. Treasury Bond Index is an unmanaged index of prices of U.S. Treasury bonds with maturities of 1 to 30 years. You cannot invest directly in an index.

[3] The Bloomberg U.S. Aggregate Bond Index is a broad-based benchmark that measures the investment-grade, U.S.-dollar-denominated, fixed-rate taxable bond market, including Treasuries, government-related and corporate securities, mortgage-backed securities (agency fixed-rate and hybrid adjustable-rate mortgage pass-throughs), asset-backed securities, and commercial mortgage-backed securities. You cannot invest directly in an index.

[4] The Bloomberg Municipal Managed Money Short/Intermediate Index measures the performance of the publicly traded municipal bonds that cover the USD-denominated short/intermediate term tax-exempt bond market, including state and local general obligation bonds, revenue bonds, insured bonds, and pre-refunded bonds. It is rules-based, and market-value weighted. You cannot invest directly in an index.

[5] The Bloomberg Municipal 1-10 Year Blend 1-12 Year Index measures the performance of short and intermediate components of the Municipal Bond Index — an unmanaged, market value-weighted index which covers the U.S. investment grade, tax-exempt bond market. You cannot invest directly in an index.

[6] The Bloomberg U.S. Corporate Bond Index is an unmanaged market-value-weighted index of investment-grade corporate fixed-rate debt issues with maturities of one year or more. You cannot invest directly in an index.

[7] The Bloomberg MBS Index tracks agency mortgage-backed pass-through securities (both fixed-rate and hybrid ARM) guaranteed by government-sponsored enterprises (GSEs) Government National Mortgage Association (Ginnie Mae) (GNMA), Federal National Mortgage Association (Fannie Mae) (FNMA), and Federal Home Loan Mortgage Corporation (Freddie Mac) (FHLMC). The index is constructed by grouping individual pools into aggregates or generics based on program, coupon, and vintage. You cannot invest directly in an index.

[8] The Bloomberg U.S. CMBS Investment Grade Index measures the market of U.S. Agency (GNMA, FNMA, and (FHLMC) and US Non-Agency conduit and fusion CMBS deals with a minimum current deal size of $300mn. You cannot invest directly in an index.

[9] Bloomberg U.S. Asset-Backed Securities (ABS) Index is the ABS component of the Bloomberg U.S. Aggregate Bond Index, a flagship measure of the U.S. investment grade, fixed-rate bond market. The ABS index has three subsectors: credit and credit cards, autos and utility. You cannot invest directly in an index.

[10] Conventional MBS are issued by the FNMA and FHLMC.

[11] Ginnie Mae MBS are issued by the GNMA.

[12] The Chicago Board Options Exchange (OEX) Volatility (VIX) Index is the ticker symbol and name for the Chicago Board Options Exchange's (CBOE) Volatility Index, a measure of the stock market's expectation of volatility based on S&P 500 index options. You cannot invest directly in an index.

[13] The S&P 500 Index tracks the performance of 500 widely held, large-capitalization U.S. stocks. You cannot invest directly in an index.

[14] The Dow Jones Industrial Average Index is a price-weighted average of 30 actively traded blue chip stocks as selected by the editors of The Wall Street Journal. You cannot invest directly in an index.

[15] The NASDAQ Composite Index is a market capitalization price-only index that tracks the performance of domestic common stocks traded on the regular NASDAQ market as well as National Market System-traded foreign common stocks and America Depository Receipts. You cannot invest directly in an index.

#BCAI-07062023-3io7ptam (7/10/2023)

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