- U.S. Treasury Curve: U.S. Treasury rates declined through 10 years, and the curve steepened modestly (See Figure 1).
- Municipal Market Technicals: May issuance was $32 billion, 9 percent lower than the same month in 2021. At about $8 billion, the monthly pace of mutual fund outflows declined.
- Corporate Market Technicals: Investment grade (IG) fixed-rate bond supply for May was $107 billion. IG bond funds reported $12 billion of outflows during the month.
- Securitized Trends: Mortgage-backed securities (MBS) delivered positive excess returns compared with Treasuries of similar maturities. Total returns for asset-backed securities (ABS) and Agency Commercial Mortgage-Backed Securities (ACMBS) were positive.
(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, Portfolio Management, Matthew Buscone; Senior Portfolio Manager Sara Chanda; Co-Head, Research, Nicholas Elfner; Co-Head, Portfolio Management, Jeffrey Glenn, CFA; Head, Municipal Trading, Benjamin Pease; and Co-Head, Research, Adam Stern, JD.)
The Treasury curve steepened during May as yields declined from 2 to 10 years while increasing slightly from 20 to 30 years (See Figure 1). The ICE BofA Merrill Lynch Option Volatility Estimate (MOVE) Index, a measure of U.S. interest rate volatility, declined in May, which contributed to the recovery in risk assets later in the month (See Figure 2). Despite continued uncertainty over inflation, a 50-basis point (bps) increase by the Federal Reserve (Fed) in the federal funds rate, and Russia’s continued war on Ukraine, yields declined, and markets edged out gains.
Treasury yields for maturities in the 2-, 5-, and 10-year ranges were lower by 16, 14 and 9bps, respectively. The 30-year yield was 5bps higher.
The May S&P 500 Index return was flat after a gain in excess of 6 percent during the last full week. The Bloomberg U.S. Aggregate Bond Index’s monthly gain was 0.64 percent, with bonds of intermediate maturity and lower credit quality within the investment grade segment leading the way.
Tighter financial conditions should slow growth over the next 12-18 months. Sentiment remains negative based on consumer and business surveys but, in somewhat of a disconnect, spending and business activity held up. Inflation expectations fell, with the 5-year Treasury Inflation-Protected Security (TIPS) breakeven, a common measure of interest rate expectations, at 3 percent by month end, compared to 3.75 percent in late March, according to Treasury Department data.
In the view of the Breckinridge Investment Committee, inflation is starting to moderate with growth slowing but still above trend. Wall Street analyst estimates for second quarter gross domestic product are in the 2 to 3 percent range area and about 2.5 percent for the full year 2022. We expect the Fed to push the federal funds rate—currently at a 0.75 to 1.0 percent target range—to the 2.25 to 2.5 percent range, in-line with the minutes of the Fed’s May meeting. The path of Fed policy gets less certain for 2023.
Municipal Market Review
Municipal yields declined across the curve (See Figure 3). Yields fell 36 and 32bps, respectively, in the 2- and 5-year maturities, while declining 22 and 18bps in 10 and 30 years. The 2s/10s curve steepened.
Municipal bonds staged a remarkable turnaround mid-month and outperformed Treasuries across the curve. After peaking at elevated levels mid-month, ratios moved lower into month-end, ending at levels closer to their long-term averages (See Figure 4).
Higher rates have led to an almost 50% decline in refunding volume year-to-date, while new money issuance has increased almost 10 percent. May municipal bond issuance of $32 billion marked a 9 percent drop compared to May 2021, about 6 percent lower than April 2022, per The Bond Buyer. May tax-exempt bond issuance was 7 percent lower than May 2021, while monthly taxable municipal bond issuance was nearly 31 percent lower year-over-year. Asset outflows continued from municipal bond funds, topping $8 billion, per Lipper, but were substantially lower than April’s total.
The Bloomberg Managed Money Short/Intermediate (1-10) Index gained 1.71 percent during May and the Bloomberg 1-10 Year Blend Index added 1.39 percent. Intermediate maturity bonds, particularly bonds in the 3- to 10-year maturity range, outperformed shorter and longer maturity issues. Bonds with the highest credit quality ratings in the investment grade spectrum performed best during the month.
Corporate Market Review
IG corporate bond spreads tightened by 4bps, per Bloomberg data, ending May at 130bps. The Bloomberg U.S. Corporate Investment Grade (IG) Index gained 0.93 percent on a total return basis and delivered an excess return of 0.79 percent compared with duration-matched Treasuries.
Bloomberg data showed that corporate bonds rated A and higher outperformed BBB-rated bonds in May, with the A-rated issues delivering the best returns. Intermediate maturity IG bonds—3 to 10-year bonds—outperformed shorter maturity bonds.
The best-performing corporate sectors were cable satellite, telecommunications, sovereigns, pharmaceuticals, and integrated oil, according to Bloomberg. The worst-performing were gaming, airlines, foreign local government, real estate investment trusts, and building materials.
Index-eligible IG bond issuance in May, per Bloomberg, was $107 billion, lower than April’s issuance by about 19 percent. Net issuance, after redemptions, was a $10 billion. According to Emerging Portfolio Fund Research, IG bond funds reported approximately $12 billion of outflows.
Securitized Market Review
MBS enjoyed a bounce back month in May. The Bloomberg MBS Index generated 70bps of excess returns. Bonds with 2.5 to 3.5 percent coupons led the way, with 3 percent coupon MBS earning 104bps in excess returns. Governmental National Mortgage Association (Ginnie Maes) MBS continued to outperform conventionals (MBS issued by the Federal National Mortgage Association (Fannie Maes) and Federal Home Loan Mortgage Corporation (Freddie Macs)), with Ginnie Maes achieving a 2bps excess return advantage over conventionals.
ACMBS earned 90bps in total return and 23bps in excess returns. Non-agency CMBS total and excess returns were negative at 36bps and 103bps, respectively.
In the asset-backed security (ABS) market, the Bloomberg ABS Index spread widened. During May, ABS backed by auto loans had a negative excess return of 21bps, while negative excess return for credit card-backed securities was 35bps. Auto loan and credit card ABS sectors each delivered a positive total return of 31bps.
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