{"id":173,"date":"2019-10-14T05:46:39","date_gmt":"2019-10-14T09:46:39","guid":{"rendered":"https:\/\/www.macroviewim.com\/blog\/?p=173"},"modified":"2019-12-03T11:48:42","modified_gmt":"2019-12-03T16:48:42","slug":"fixed-income-market-summary-december-2018","status":"publish","type":"post","link":"https:\/\/www.macroviewim.com\/blog\/fixed-income-market-summary-december-2018\/","title":{"rendered":"Fixed Income Market Summary – December 2018"},"content":{"rendered":"

US Treasuries \u2013 Massive equity market volatility in December propelled treasuries to their best month of 2018 and pushed them into positive territory for the year. In December, the Federal Reserve hiked interest rates for the 4th time in 2018 and continued to maintain that the political and equity market drama would not deter them from their tightening path. Significant flattening of the yield curve may be further cause for concern in risk markets. Municipals \u2013 Municipals performed strongly in December to close out a very productive
\nquarter. Light supply continues to be a big story and contributed to the price uptick. Municipal performance ranked 2nd among major sectors in 2018, but the sector cheapened slightly versus treasuries in December.
\nCorporates \u2013 Corporate bonds shook off weak performance in the first two months of the quarter to rally back in December. Despite a strong month, the sector experienced a down year
\nfor the first time since 2013. In addition, corporate spreads to equivalent Treasuries widened during the month, indicating continued uncertainty for corporate earnings and for the general economic landscape.
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\nBOND MARKET PERFORMANCE SNAPSHOT:<\/p>\n\"\"\n

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Treasuries and municipals put together a strong November. However, major bond sectors are still down across the board as we approach the end of 2018, shown by the ETFs in the table above. Of the investment grade credits, municipals continue to be the best performer in 2018 after a strong November. High yield and corporates were the only sectors posting negative returns in the month. LQD, the investment grade corporate bond ETF, is on pace for its worst year since opening in 2002, down over 5.5%.<\/p>\n

TREASURY MARKET OVERVIEW:<\/strong><\/h3>\n

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TREASURY YIELD SUMMARY:<\/strong><\/h5>\n

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The 10-year Treasury yield continued its tumble from the November 2018 peak, falling 30 basis points during December. For the year, the 10-year rose only 28 basis points, well below the\u00a02018 high of approximately 85 basis points. Undoubtedly, the big contributor to this demand\u00a0for bonds was continued volatility in the equity markets due to trade concerns and that Federal\u00a0Reserve tightening could lead to a recession. The 9% drop in the S&P 500 in December – its\u00a0worst month in 7 years and the worst December since the Great Depression \u2013 predictably drove\u00a0investors to seek safety and dry land as global stocks across the board plunged. As is often the\u00a0case, Treasuries were a source of protection for investors.
\nThe Federal Reserve continued its path of monetary policy tightening, raising rates for the 4th\u00a0time in 2018 at their December meeting. This marked the 9
\nth time that the Fed has raised\u00a0during the current cycle that begin in 2015. Chairman Powell reiterated that monetary policy\u00a0decisions are based on economic data and that the Fed is undeterred by market activities or\u00a0threats from the President. Powell expressed no complaints and sees no changes in the Fed\u2019s\u00a0$50 billion monthly balance sheet unwinding, saying it has been smooth and running on \u201cauto-pilot\u201d as planned. Moreover, FOMC inflation forecasts were lowered, although inflation\u00a0remains very near the Fed\u2019s 2% target.
\nWith all this in mind, the market still expects the Fed to cool down the speed of its monetary\u00a0policy tightening. At the December meeting, the Fed reduced their projections from 3 hikes in\u00a02019 to 2. However, Fed funds futures have that projection closer to 1, and possibly 0 for next\u00a0year.
\nAfter significant flattening during the market swoon, Treasury yields continued to dive during\u00a0December. As shown in the chart above, maturities across the board experienced a significant\u00a0decline in yields. In fact, the 2-year Treasury yield experienced its biggest monthly decline in a\u00a0decade. Thus, the 2-10 spread continues to hover around 0.20% at the end of the year, virtually unchanged from the end of November.
\nA notable development in the Treasury market is the limited movement in the 1-year Treasury yield. The 1-year yield now is higher than all maturities of 2-7 years. Normally, investors expect\u00a0higher returns in longer-dated bonds to compensate them for the risk of lending money for a\u00a0longer time period. However, if investors think short-term economic outlook is poor, they may\u00a0sell-off shorter term bonds in favor of longer-term bonds. This raises the yield on short-term\u00a0bonds relative to long-term bonds. Thus, an inverted yield curve is often seen as an indicator of\u00a0a forthcoming recession. Combined with a steadfast Fed, we believe the government\u00a0shutdown, looming deficit battle and recession concerns are making investors nervous, causing\u00a0this inversion phenomenon to play out in the Treasury market.<\/p>\n

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MUNICIPAL MARKET OVERVIEW:<\/strong><\/h3>\n

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TAX-EXEMPT MUNICIPAL YIELD SUMMARY:<\/strong><\/h5>\n

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TAX-EXEMPT MUNICIPAL YIELDS AS A PERCENTAGE OF TREASURY:<\/strong><\/h5>\n

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Though not to the same degree as Treasuries, municipal bonds felt the effects of the equity\u00a0market turmoil and finished 2018 with gains for the second straight year. This is impressive
\nconsidering that municipals were down 2 of the first 3 quarters. Maturities across the\u00a0municipal curve declined in December, with the belly of the curve, 5-10 years, experiencing the
\nlargest move down.
\nLooking ahead, supply dynamics appear to be favorable. 30-day forward supply hit a 2018 low\u00a0in the final week in December. Additionally, Citigroup projects $21.5 billion of issuance versus\u00a0$26.3 billion that will mature or be called in January. This doesn\u2019t even incorporate the $15.8\u00a0billion received from interest payments. Therefore, Citi believes the municipal market is\u00a0expecting the so-called \u201cJanuary Effect\u201d, which would be a contrast from historical\u00a0fundamentals in the municipal market. Historically, January has been a period of flat or
\nmarginally positive net issuance, which obviously is not the case this time around.
\nNotwithstanding, municipals have only posted negative returns in January twice in the past\u00a0decade. Of course, one of those was 2018 when the market was whipsawed by impacts of the\u00a0federal tax-cut law.
\nOn the demand side, although municipals sustained strong performance throughout the end of\u00a0the year, mutual fund investors didn\u2019t seem to take an aggressive approach until late in
\nDecember. According to Lipper US Fund Flows data, after 12 straight weeks of outflows from\u00a0municipal mutual funds, the streak was broken as $255 million was added during the week
\nended Wednesday December 19. This was followed by an inflow of $931 million the following\u00a0week, the most since July.
\nFrom a relative value perspective, 1-year municipals curve continue to get increasingly\u00a0expensive versus Treasuries. The stationary 1-year Treasury we discussed above doesn\u2019t seem
\nto be affecting the municipal market just yet with the 1-year municipal still yielding less than\u00a0longer dated maturities. In addition, the municipal curve continues to be much steeper, as the\u00a02-10 spread is 32 basis points larger in the municipal market versus the Treasury market. Thus, the value in municipals continues to reside on the longer end of the curve for investors willing to\u00a0extend duration.
\nSeveral of the big players in the asset management business project a strong year ahead for\u00a0municipals. BlackRock, Oppenheimer, JP Morgan and Goldman Sachs came out with bullish\u00a0calls on the sector for 2019. BlackRock pointed to the Fed\u2019s reduced outlook for hikes in\u00a0combination with investors looking for increased tax havens after they see the limits on state\u00a0and local tax deductions from recent legislation. In addition, JP Morgan and Goldman Sachs\u00a0specifically pointed to the relative value of municipals versus Treasuries on the long-end of the\u00a0curve and pent up demand as reasons for strong anticipated performance.
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\nCORPORATE MARKET OVERVIEW:<\/p>\n

INVESTMENT GRADE CORPORATE YIELD SUMMARY:<\/p>\n\"\"\n

CORPORATE BOND SPREADS VERSUS TREASURIES:<\/p>\n\"\"\n

Corporate bonds finally caught some of the benefit of volatility in the equity markets, with\u00a0yields across the corporate curve falling substantially in December. Despite a strong final
\nmonth, corporates still finished negative on the year and fell in 7 of 12 months during 2018.\u00a0Corporates across the entire credit spectrum experienced losses, with junk rated credits\u00a0suffering a more significant decline. In addition, corporate spreads to Treasuries edged up\u00a0during the month, as investors continue to find more safety in Treasuries relative to corporates. High grade credit spreads have now reached the highest level since early 2016. On the supply\u00a0side, investment-grade issuance was the lowest in December since 1995, which may provide\u00a0support for corporates.\u00a0High yield bonds also limped into the close in 2018 finishing with losses for the first time since\u00a02015 and only the 3rd time since 2008. This is not surprising given their typically high correlation\u00a0to risk assets. US leveraged loan prices also dropped to their lowest level in two years as\u00a0investor fears about trade wars and corporate profit growth overflowed from corporates and\u00a0into the loan market. This came after investors pulled money from leveraged loan funds for\u00a0three straight weeks in December, which collectively totaled the biggest outflow in four years.US leveraged loan issuance is expected to drop next year to about $375 billion versus $400 billion in 2018, which may provide additional support to a market that surprisingly finished with\u00a0positive returns on the year.<\/p>\n

There are several signs that we are entering a late cycle in corporate credit. US corporate debt\u00a0as a percentage of GDP has surpassed levels during the financial crisis, a harbinger of increasing\u00a0credit defaults once profits shrink materially. Corporates at the lowest level of investment grade credit (BBB) continue to slowly make up a larger percentage of the market, as the\u00a0number approached 50% by the end of the year. Financing costs are potentially on the rise,\u00a0input costs are up and companies in the BBB range have been issuing more bonds to fund share\u00a0buybacks and acquisitions.
\nAdd Altria Group to the list of companies joining the ranks of BBB in December. The company\u00a0was downgraded for a recent $12.8 billion stake in Juul Labs, a San Francisco based e-cigarette\u00a0company. S&P global had formerly rated the company A-, but multiple recent acquisitions have\u00a0brought the tobacco giant\u2019s leverage to nearly three times earnings. Most of the deal is\u00a0projected to be financed with debt. Altria joins a growing list of companies that have sacrificed\u00a0credit ratings in pursuit of acquisitions. Investors have voiced concerns that credit rating\u00a0agencies have provided too much leniency when determining credit ratings after large deals,\u00a0which often come with significant piles of debt relative to a company\u2019s earnings. However, that\u00a0is not the case in this situation, and similar ratings cuts in Anheuser-Busch InBev and Japanese\u00a0pharmaceutical giant Takeda will likely mean that companies will have to get more creative in\u00a0financing deals, putting forth equity or achieving consolidation without adding leverage.<\/p>\n","protected":false},"excerpt":{"rendered":"

US Treasuries \u2013 Massive equity market volatility in December propelled treasuries to their best month of 2018 and pushed them into positive territory for the year. In December, the Federal Reserve hiked interest rates for the 4th time in 2018 and continued to maintain that the political and equity market drama would not deter them… Read more »<\/a><\/p>\n","protected":false},"author":2,"featured_media":0,"comment_status":"open","ping_status":"open","sticky":false,"template":"","format":"standard","meta":[],"categories":[21],"tags":[54,48,4,7,6,15],"_links":{"self":[{"href":"https:\/\/www.macroviewim.com\/blog\/wp-json\/wp\/v2\/posts\/173"}],"collection":[{"href":"https:\/\/www.macroviewim.com\/blog\/wp-json\/wp\/v2\/posts"}],"about":[{"href":"https:\/\/www.macroviewim.com\/blog\/wp-json\/wp\/v2\/types\/post"}],"author":[{"embeddable":true,"href":"https:\/\/www.macroviewim.com\/blog\/wp-json\/wp\/v2\/users\/2"}],"replies":[{"embeddable":true,"href":"https:\/\/www.macroviewim.com\/blog\/wp-json\/wp\/v2\/comments?post=173"}],"version-history":[{"count":4,"href":"https:\/\/www.macroviewim.com\/blog\/wp-json\/wp\/v2\/posts\/173\/revisions"}],"predecessor-version":[{"id":185,"href":"https:\/\/www.macroviewim.com\/blog\/wp-json\/wp\/v2\/posts\/173\/revisions\/185"}],"wp:attachment":[{"href":"https:\/\/www.macroviewim.com\/blog\/wp-json\/wp\/v2\/media?parent=173"}],"wp:term":[{"taxonomy":"category","embeddable":true,"href":"https:\/\/www.macroviewim.com\/blog\/wp-json\/wp\/v2\/categories?post=173"},{"taxonomy":"post_tag","embeddable":true,"href":"https:\/\/www.macroviewim.com\/blog\/wp-json\/wp\/v2\/tags?post=173"}],"curies":[{"name":"wp","href":"https:\/\/api.w.org\/{rel}","templated":true}]}}