- U.S. Treasury Curve: Yields were slightly lower across much of the curve. The curve’s shape was mostly unchanged.
- Municipal Market Technicals: Issuance declined in May. Year-to-date, 2021 issuance is 7 percent higher than 2020, despite May 2021 issuance that was 23 percent lower year-over-year (Y/Y).
- Corporate Market Technicals: Total investment grade (IG) corporate new issuance was up 6 percent in May, at $138 billion, per Bloomberg. IG fund flows of about $13 billion were lower than April.
- Securitized Trends: Spreads widened across most mortgage-backed securities (MBS) segments, while they tightened for agency commercial MBS (CMBS), non-agency CMBS, and asset-backed securities (ABS).
Counterbalancing forces affected all markets in May. Offsetting positive effects of continued fiscal stimulus and economic reopenings were inflation concerns and some disappointing employment data. With little to tip sentiment conclusively either positively or negatively, a sense of inertia characterized the environment.
Businesses and individuals benefited from continuing fiscal stimulus, particularly the Consolidated Appropriations Act passed in December 2020 and the American Rescue Plan passed earlier in 2021. Proposed additional spending was emerging in infrastructure bills and, at the end of the month, the Biden administration’s $6 trillion budget. Second quarter data and full-year estimates for gross domestic product remained strong.
At the same time, inflation concerns remained. The Consumer Price Index, excluding food and energy, rose 0.8 percent in April over March and 4.2 percent Y/Y, higher than recent trends. Many observers attributed higher inflation readings to low base effects from last year and temporary spending increases in three key areas: lodging away from home, airline fares, and used cars. These factors supported a transitory inflation narrative, while news of supply chain shortages and interruptions contributed to concerns of more persistent upward rate pressures.
Also feeding a sense of unease was somewhat lackluster April employment data and a leveling of vaccinations, as states began to ease pandemic-related restriction ahead of the summer season.
During May, Treasury yields slipped lower in most maturities. The 10-year Treasury yield closed May at 1.60 percent, off 3bps from April’s 1.63 percent close.
Municipal Market Review
Municipal bond yields increased marginally in the 2- to 5-year range, were unchanged at 7 years, and declined 6bps at 10 years, per Bloomberg data (see Figure 1). The broad Bloomberg Municipal Bond Index was up 0.30 percent, narrowly underperforming the Bloomberg U.S. Treasury Index, which was up 0.34 percent.
The 2s5s curve steepened while the 2s10s and 2s30s curves were 2bps and 7bps flatter, respectively (see Figure 2). Municipal/Treasury (M/T) ratios increased in short- to intermediate term maturities, with the largest increases occurring in the short-term segment of the curve. Ratios closed May at 60 percent, 62 percent, and 66 percent at the 5-, 10- and 30-year maturities, respectively (see Figure 3).
Supply and demand technicals supported the market. According to The Bond Buyer, during May 2021 tax-exempt and taxable municipal new issuance were lower by a combined $7 billion or 23 percent compared with 2020. Continuing a trend dating back to passage of the Tax Cut and Jobs Act of 2017, taxable municipal bonds continued to comprise about 20 percent of total issuance.
We expect technicals to remain supportive entering the summer months, when maturing bonds have driven high reinvestment demand. Street analysts estimate $122 billion in reinvestment volume during the third quarter and negative net supply of $32 billion.
Demand in May was strong. Mutual fund inflows exceeded $3.6 billion for the month and total more than $48 billion year-to-date, per Bloomberg.
The Biden administration released its proposed $6 trillion budget, which included spending proposals, that could tend to increase municipal bond supply. The budget overall proposes a net increase of $2.4 trillion in taxes over 10 years. Proposals include a corporate tax hike to 28 percent and raising the top individual tax rate to 39.6 percent. Increased taxes, if enacted would logically serve to heighten demand for municipal bonds due to the tax benefits.
For May, the Bloomberg 1-10 Year Blend Index gained 0.07 percent and the Managed Money Short/Intermediate (1-10) Index was flat. Per Bloomberg, lower-rated bonds outperformed higher-rated bonds. Bonds with longer maturities outperformed shorter maturities.
Throughout May, we continued to be selective when engaging in the primary or new issue market, where competitive bidding tended to push prices higher and yields lower. We continued to look for opportunities to capture value in the secondary market among bonds being traded in the secondary market that we considered to be relatively better value than those available in the new issue market.
Corporate Market Review
The overall 2021 bias to tightening corporate bond spreads continued through May. Investment grade corporate bond spreads tightened by 4bps on the month to finish at 85bps. The BBG IG Corporate Index IG Index (the “Index”) gained 0.77 percent on a total return basis and delivered an excess return of 0.47 percent over duration-matched Treasuries.
Bloomberg’s investment grade corporate indices showed that BBB-rated bonds generally outperformed other higher-rated bonds in the investment grade category on both a total return and excess return basis. Corporate bonds with 5- to 10-year maturities earned higher total and excess returns relative to shorter maturities, second in performance only to bonds in the long corporate segment of the index.
According to Bloomberg, the best-performing sectors in May were Oil Field Services, Midstream and Independent Energy, Refining, and Wirelines. The worst-performing sectors were Cable/Satellite, Supermarkets, Consumer Cyclical Services, and Healthcare Real Estate Investment Trusts.
Index-eligible IG fixed-rate corporate bond issuance in May, per Bloomberg, was $125 billion, up about 20 percent month-over-month. Demand for bonds remained strong. Fund inflows totaled approximately $13 billion, per Wells Fargo.
We continue to view credit fundamentals as positives for the IG market. Earnings have been growing and should drive credit metric improvement across most sectors. Spreads are notably tight by historic standards, although higher-quality IG asset classes offer even less spread and IG corporates benefit from foreign demand as Europe and Japan yield spreads are lower. Technical conditions are market neutral in our view.
Securitized Market Review
According to Bloomberg securitized indices, agency CMBS was among the best-performing securitized sectors in May. ABS also delivered positive performance on a total and excess return basis. Credit cards marginally outperformed autos as lack of credit card-backed debt supply supported prices. MBS trailed other securitized sector returns.
During the month, MBS prepayment speeds slowed, as mortgage rates increased, according to government-sponsored entities. Despite continued robust supply, Fed MBS purchases overwhelmed the demand side of the equation, keeping spreads near historically tight levels. Net issuance is already over $315 billion so far in 2021. Strong first quarter and record-breaking April issuance pushed year-to-date total 2021 net issuance to 62 percent of 2020’s total in just four months, based on data from federal mortgage agencies.
The Fed has been buying an average of $6 billion of mortgage bonds per day, as total aggregate purchases reached nearly $2 trillion since March 2020. During two prior QE operations, final MBS purchases tallied $1.35 trillion and $1.4 trillion.
With housing prices rising at the fastest pace since 2006, the housing market appears to have recovered. As speculation increased during May about the end of the current QE operation, Boston Federal Reserve Bank President Eric Rosengren pointed out that mortgage bonds are an obvious candidate for tapering before Treasuries.
Per Bloomberg index data for May, agency CMBS and nonagency CMBS each earned a 37bps excess return. MBS delivered an excess return of negative 36bps. Within the ABS segment, excess returns were 15bps for credit card-backed issues and 11bps for auto loan-backed bonds.
DISCLAIMER: The opinions and views expressed are those of Breckinridge Capital Advisors, Inc. They are current as of the date(s) indicated but are 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.
Nothing contained herein should be construed or relied upon as financial, legal or tax advice. All investments involve risks, including the loss of principal. Investors should consult with their financial professional before making any investment decisions.
While Breckinridge believes the assessment of ESG criteria can improve overall credit risk analysis, there is no guarantee that integrating ESG analysis will provide improved risk-adjusted returns over any specific time period.
Some information has been taken directly from unaffiliated third-party sources. Breckinridge believes such information is reliable but does not guarantee its accuracy or completeness.
Any specific securities mentioned are for illustrative and example only. They do not necessarily represent actual investments in any client portfolio.
BLOOMBERG® is a trademark and service mark of Bloomberg Finance L.P. and its affiliates (collectively “Bloomberg”). BARCLAYS® is a trademark and service mark of Barclays Bank Plc (collectively with its affiliates, “Barclays”), used under license. Bloomberg or Bloomberg’s licensors, including Barclays, own all proprietary rights in the Bloomberg Barclays Indices.
Neither Bloomberg nor Barclays approves or endorses this material, or guarantees the accuracy or completeness of any information herein, or makes any warranty, express or implied, as to the results to be obtained therefrom and, to the maximum extent allowed by law, neither shall have any liability or responsibility for injury or damages arising in connection therewith.