Commentary published on October 13, 2022
September 2022 Market Commentary
- U.S. Treasury Curve: U.S. Treasury rates were higher, most notably in the 2- to 10-year range, and the curve inversion deepened (See Figure 1).
- Municipal Market Technicals: September issuance was $25 billion, 43 percent lower the same month in 2021, and almost 38 percent lower than August 2022. Mutual funds saw outflows of more than $8 billion.
- Corporate Market Technicals: Investment grade (IG) fixed-rate bond issuance for September was $103 billion. IG bond funds reported $12 billion of outflows during the month.
- Securitized Trends: Mortgage-Backed Securities (MBS) underperformed Treasuries on an excess return basis for the second consecutive month. The asset-backed securities (ABS) index earned positive excess return, with contributions from auto loan and credit card ABS.
(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.)
In a virtual repeat of August, financial conditions continued to tighten in September with a sharp sell-off in equities and bonds inspired by hawkish Federal Reserve (Fed) activity, as inflation remains too high.
Treasury yields increased across the curve, with the 2-, 3-, 5-, and 7-year maturities all jumping by more than 70 basis points (bps) while the 10- and 30-year spots gained 68 and 52bps, respectively (See Figure 1).
The Fed raised the fed funds rate another 75bps at its September meeting. Several forecasts have the Fed hiking by 75bps at its upcoming November meeting and another 50bps in December. The Federal Open Market Committee is not scheduled to meet in October. Fed officials signaled the intention of continuing to hike until the funds level hits an end point, of 4.6 percent in 2023.
The ICE/Bank of America Merrill Lynch MOVE Index, a measure of bond market volatility, continued to increase in September, illustrating the uncertainty and concern that characterized investor sentiment (See Figure 2).
The Chicago Board of Exchange VIX Index, a measure of equity market volatility, also approached year-to-date (YTD) highs, illustrating that all markets continued to adjust to a world where Quantitative Easing is being replaced by Quantitative Tightening (QT). We recognize that as the Fed advances on its rate-rising path, the risk of a policy error is becoming more likely. We are cautious on risk assets and expect wider credit spreads.
Economic data continued to show conflicting signs that the Fed’s interest rate increases were reducing inflation or slowing economic growth meaningfully. For example, Bloomberg (BBG) reported that Bureau of Economic Analysis (BEA) data showed real consumption spending rose at a lower 0.1 percent month-over-month (M/M) in August, and July data was revised downward. Meanwhile, personal consumption expenditures, the Fed’s preferred inflation measure, stayed high, suggesting sustained price pressures. In addition, the labor market remains tight with upward pressure on wages.
Housing starts rose, per U.S. Census Bureau data, while home building permits fell in August. The housing starts data was stronger than expectations, BBG reported, while lower single- and multifamily permit issuance, may indicate that higher mortgage rates are weighing on housing demand.
The Atlanta Fed Bank’s GDPNow estimate at September 30 was 2.4 percent on an annualized basis.
During September, the BBG U.S. Treasury Bond Index declined 3.45 percent. The BBG U.S. Aggregate Bond Index dropped 4.32 percent. The equity benchmark S&P 500 Index fell 9.34 percent.
Municipal Market Review
Municipal yields increased across the curve during the month (See Figure 3). Yields rose 81bps in 2-years, 80bps in 5-years, while the 10- and 30-year spots closed the month 71 and 61bps higher.
Similar to Treasuries, municipal curves flattened over the month with the 2s/10s and 2s/30s closing 10bps and 20bps flatter.
Municipal/Treasury (M/T) ratios improved across the curve; particularly in the 2- to 5-year range. (See Figure 4).
The Bond Buyer reported that municipal bond issuance in September was down 38 percent month-over-month and 43 percent year-over-year, “as issuers eschewed the market amid another Federal Reserve rate hike and severe global market volatility.” Taxable municipal bond issuance was down 84 percent from a year ago, while tax-exempt issuance was down 29 percent from 2021.
Complicating supply conditions were continued elevated outflows from mutual funds which exceeded $8 billion in September, per Lipper/Refinitiv, to reach a record level exceeding $90 billion year-to-date.
The BBG Managed Money Short/Intermediate (1-10) Index declined 3.05 percent and the BBG 1-10 Year Blend Index was down 2.63 percent. Shorter-maturity bonds outperformed longer-maturity issues. Higher-rated bonds tended to outperform lower-rated bonds, with bonds rated AA delivering the best performance.
Corporate Market Review
IG corporate bond spreads widened by 18bps, per BBG data, ending September at 159bps. The BBG U.S. Corporate Investment Grade (IG) Index fell 5.26 percent on a total return basis, with a negative excess return of 1.42 percent compared with duration-matched Treasuries.
As the Fed continues to raise the fed fund rate, corporate bond market conditions reflect the changing landscape. Yields on IG bonds in September reached their highest level in more than a decade. Corporate gross and net leverage decreased in recent years, while cash on balance sheets increased; both are favorable indicators of overall financial health. Meanwhile, moving in a range from about 150 to 160bps, spreads have yet to reach levels seen in past recessionary periods. They are more reflective of concerns over future earnings, so investors will watch third quarter earnings reports carefully for signs.
For the month of September, the best-performing sectors were Supranationals, Packaging, Diversified Manufacturing, Airlines, and Environmental. The worst-performing were transportation services, Sovereigns, Cable Satellite, Wirelines, and Railroads. Bonds rated AA+ bonds were the best performers across the investment grade quality spectrum, while bonds rated A were the worst.
Index-eligible IG bond issuance in August, per BBG, was $ $103.4 billion, about $31 billion lower than August. Net issuance, after redemptions, was $4 billion. According to Emerging Portfolio Fund Research, IG bond funds reported approximately $12 billion of outflows in the month of September.
Securitized Market Review
Continued rate volatility and the Fed no longer buying MBS for the first time since 2011 led to one of the worst months on record for the MBS sector. The BBG MBS Index experienced a negative 5 percent total return and an excess return of negative 1.9 percent. Lower coupons underperformed higher coupons and Government National Mortgage Association MBS underperformed conventional MBS, as there was speculation that the Bank of Japan sold MBS to support the nation’s currency.
Agency Commercial MBS (ACMBS) outperformed other IG sectors given their defensive characteristics. Market volatility negatively impacted non-agency CMBS as spreads widened to close near YTD wides.
The ABS sector delivered another strong month of performance, generating 13bps of excess returns, as spreads tightened. Market conditions impacted supply with only $11 billion issued in September, leaving YTD volume down 7 percent relative to the comparable period last year. Auto ABS credit performance continues to normalize, with default rates and loss severities up, albeit still below pre-pandemic levels.
 The 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.
 Conventional MBS are issued by the Federal National Mortgage Association and the Federal Home Loan Mortgage Corporation.
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