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Investing

Commentary published on April 7, 2021

March 2021 Market Commentary

Summary

  • U.S. Treasury Curve: Yields increased from two years and out, and the curve steepened as Treasuries sold off. The 10-year and 30-year yields were 34 basis points (bps) and 27bps higher, respectively.
  • Municipal Market Technicals: Issuance surged over the course of the month, increasing 105 percent year-over-year, and was easily absorbed as demand was strong.
  • Corporate Market Technicals: Investment grade (IG) new issuance picked up sharply in March with $201 billion priced. IG fund flows slowed to $6 billion.
  • Securitized Trends: Spreads for mortgage-backed securities (MBS) and agency commercial MBS (ACMBS) were rangebound while asset-backed securities (ABS) moderately widened.

Market Review

Bond market conditions during March continued the rising rate and relation themes that emerged in February. Accelerating COVID-19 vaccinations and the approval of the $1.9 trillion American Rescue Plan Act buoyed investors and heightened expectations for a strong economic recovery. As rates on the 10-year Treasury surpassed 1.70 percent, Fed Chair Jerome Powell sought to allay inflation fears by saying that interest rates would remain at the zero-lower bound through 2023. He also reiterated the Fed’s focus would stay on supporting economic and job recoveries. Stocks, as measured by the S&P 500 Index, hit several new highs as investors exhibited little concern for risk.

The municipal bond yield curves ended the month essentially unchanged. (See Figure 1). Higher supply and strong demand supported the market (See Figure 2). According to Bloomberg Barclays, municipal bonds outperformed Treasuries on a total return basis across the curve.

Based on the Bloomberg Barclays IG Corporate Index, corporate bond yield spreads widened by 1bp. Index-eligible IG bond issuance in March per Barclays was the highest monthly total year-to-date at just over $200 billion. Fund inflows totaled approximately $5.8 billion, per Wells Fargo.

Municipal Market Review

While Treasury yields were climbing, municipal bond yields declined 5 basis points (bps) in 5-year and 30-year while the 10-year fell by 2bps. Due to the modest rate decline, yield curves were unchanged to slightly steeper. The 2s10s closed at 98bps and 5s10s at 61bps.

After rising early in the month off a trend extending from February, Municipal/Treasury (M/T) ratios declined again, falling near mid-February lows (See Figure 3).

According to The Bond Buyer, March new issue supply totaled over $41 billion, more than double the March 2020 total when issuance was stymied by emergence of the COVID-19 pandemic. The total is above the 10-year average for March of approximately $33 billion, and the highest March level since 2016. Taxable municipal bonds comprised about 19 percent of the total. Demand was strong among financial companies, foreign buyers and mutual funds.

For March, both the Bloomberg Barclays 1-10 Year Blend Index and the Managed Money Short/Intermediate (1-10) Index gained 0.40 percent. Per Barclays, lower-rated bonds outperformed higher-rated bonds. Bonds with longer maturities outperformed shorter maturities.

While the quarter’s yield changes were dramatic, we often see markets experience significant short-term changes in response to near-term influences and then readjust with the passage of time. We believe that the volatility of first quarter represents just such a circumstance. We expect that municipal credit will continue to heal in 2021 on abatement of the COVID-19 pandemic and a strengthening economy as supported by fiscal stimulus. 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

Index-eligible IG corporate bond spreads were 1bp wider in March, closing the month at 91bps. The Bloomberg Barclays Credit Index was flat month-over-month at 86bps, delivering an excess return of 29bps compared with duration-matched Treasuries.

On an excess return basis, AAA-rated bonds outperformed AA- and A-rated bonds. AAA-rated bond spreads tightened 4 bps, while spreads tightened by 3bps for AA-rated bonds and widened 2bps for A-rated bonds. BBB-rated bond spreads tightened by 1bp on the month and delivered the strongest excess return among the ratings cohorts. On an excess return basis, longer-term maturities outperformed shorter-term bonds.

The BBG U.S. Corporate Investment Grade Bond Index fell 1.72 percent for the second consecutive month. According to Barclays, the best-performing sectors were Wirelines, Sovereigns, Cable/Satellite, Telecommunication and Midstream energy companies. The worst-performing sectors were Apartment Real Estate Investment Trusts, Banking, Property & Casualty Insurance, Metals and Mining and Brokers/Asset Managers.

Index-eligible, fixed-rate gross IG supply was $200 billion over the month, per Barclays, representing a 45 percent increase over February. IG fund inflows were about $5.8 billion in March with intermediate-duration funds attracting $5.3 billion while long-end funds saw about $5.7 billion of outflows, per Wells Fargo. Foreign and insurance demand remain solid sources of demand.

Our view is that as the economy recovers, corporate revenues and earnings will rebound sharply, which will drive improved credit metrics across most sectors. Issuers are expected to take a balanced approach in deploying excess cash raised in the past year. We believe that valuations are tight but not unreasonable in a global context and relative to IG bond alternatives. Spread widening in short maturities has created select relative value opportunities.

Securitized Market Review

Strength in MBS during early March stretched across the coupon stack, including the 1.5 coupon, which was unusual because lower coupons take on longer duration as rates rise. Hedging and Fed buying remained relative value drivers in the coupon. The Fed decided to drop the 1.5 percent coupon from its buying program. We sold our exposure to the coupon earlier in the month.

We further underweighted our allocation to Government National Mortgage Association (GNMA) MBS during the quarter relative to the index as relative value and market conditions, including the expiration of pandemic-related forbearance programs, may accelerate prepayments in the sector. The Fed’s decision to stop buying ACMBS mid-month had little effect on spreads due to continued demand for high grade paper.

According to Bloomberg Barclays indexes, securitized sectors reported the following excess returns results in March. Agency MBS produced a negative 17bps. CMBS declined 4bps and Agency CMBS gained 11bps. ABS detracted 3bps, with bonds backed by credit card debt dropping 3bps and those backed by auto loans falling 7bps.

 

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