In this piece, we take key points from our firm's most recent Bond Policy Meeting and share them with our readers. Hopefully, this piece will provide some insight into the economy and fixed income markets and give you a sense of how our team is thinking about recent trends and developments.
Crawford Bond Policy
- We believe high grade bond yields will continue to remain rangebound over the near term. Significant yield changes would necessitate meaningfully higher inflation data or substantial labor market deterioration.
- There is likely more room for yield downside driven by weakening labor market and consumer data than upside driven by higher inflation.
- We continue to believe a “no landing” economic scenario is very unlikely. Consequently, our policy has not changed in terms of being appropriately positioned for a “hard” or “soft landing.”
- Our strategies are positioned to outperform in both scenarios based on sector weights (bias to agency/municipal/defensive corporates) and yield curve positioning (longer duration).
- Our Core and Municipal strategies are positioned to:
- Preserve capital with a strong bias to high quality (sector and issuer credit strength).
- Benefit from total return as rates adjust to a more balanced economic environment (yield curve positioning and maturity extension).
- Produce a high level of current portfolio income (bias to higher-yielding spread sectors and above-average coupons).
Treasury Yields as of 5/8/2024 (Post-Fed Meeting)
- Nominal U.S. Treasury security yields have moved higher across the curve between March and May Bond Policy meetings. This was primarily driven by a move higher in Real interest rates against a decline in inflation expectations (measured by TIPs Breakevens).
- This behavior reflected continued strong economic growth data, persistent inflationary readings above the Fed’s target level, and an increased likelihood that the Fed will maintain its current rate policy for longer than the market originally expected.
- This was further illustrated in Fed Funds Futures which have dropped from approximately 6 cuts at the beginning of 2024, to 3 after the March Fed meeting, to 1, currently.
- The 3-month/10-year and 2-year/10-year Treasury curves flattened 3 and 22 basis points, respectively, between Bond Policy meetings, reflecting the market's conviction for a “higher-for-longer” rate cycle, and the increased probability of a “no-landing” economic cycle, wherein current rate policy is neutral and longer-term interest rates adjust upward.
- Bond yields will continue to be driven primarily by inflation and labor market data, which have the highest probability of influencing Fed rate policy. Secondary drivers include the rising likelihood of a U.S. Treasury supply glut as rising interest costs and persistent deficits support higher long-term yields.
- Recent labor market and consumer data indicate we may be at a turning point in the cycle where demand could soften, but inflation data has not demonstrated movement that would enable the Fed to shift policy.
Corporate Bond Market
- Broad-based demand for high-grade corporates has continued despite record levels of new issue supply.
- Year-to-date high-grade gross new issue volume is up 34% year-over-year.
- Demand is unlikely to subside, despite tight relative value (yield spreads), based on historically attractive absolute yield levels.
- Issuers are paying less relative to outstanding issues (concession).
- There is more in total orders relative to issue size (books).
- Yield spreads to attract orders from initial talk to final pricing are coming down more (compression).
- The fundamental backdrop remains supportive as indicated by Rating Agencies announcing more upgrades than downgrades, year-to-date, and the continued strength of U.S. economic data.
- Investment-Grade Corporate Option-Adjusted Spread (OAS) evaluates the additional compensation investors require for credit risk being taken above a risk-free treasury security.
- Continued spread compression despite rising interest rates demonstrates the market's confidence in corporate fundamentals and the outlook for the economy.
Municipal Bond Market
- Municipal Bond “AAA” scale yields have moved higher across the curve since our March Bond Policy meeting.
- Gross new issue municipal supply year-to-date is 23% higher than the same period last year (tax-exempt supply +37%). Municipal supply has historically been above average in Presidential election years.
- While summer months typically experience net negative supply, supporting bond prices, this year is likely to be less supportive with the election looming.
- Investor demand has more than offset any potential technical pressure: mutual fund flows have been positive for 16 straight weeks, and net inflows total $7.6 Billion year-to-date.
- The increase in municipal yields has primarily been driven by correction in sympathy with Treasury securities. Municipal bonds have outperformed Treasury securities on a relative basis, however, leading to lower/tighter Muni/Treasury ratios. While ratios indicate relative value richness from a historical perspective, ratios have moved higher off of recent lows.
- High-grade essential service and tax-backed issues continue to outperform healthcare, charter school, and higher education credits from the perspective of upward rating revisions. This demonstrates fundamental support for high quality issuers.
Disclosures:
Crawford Investment Counsel (“Crawford”) is an independent investment adviser registered under the Investment Advisers Act of 1940, as amended. Registration does not imply a certain level of skill or training. More information about Crawford, including our investment strategies, fees, and objectives, can be found in our Form ADV Part 2and/or Form CRS, which is available upon request.
The opinions expressed are those of Crawford. The opinions referenced are as of the date of the commentary and are subject to change, without notice, due to changes in the market or economic conditions and may not necessarily come to pass. There is no guarantee of the future performance of any Crawford portfolio. Crawford reserves the right to modify its current investment strategies and techniques based on changing market dynamics or client needs.
Material presented has been derived from sources considered to be reliable, but the accuracy and completeness cannot be guaranteed.
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