Weekly Market Review
In this recap, we summarize market performance and market moving news from the prior week.
MACRO
- We’re leading with the markets this week given the recent, significant moves since the October CPI report. After the U.S. 10-year yield rallied down from 5%, we’re holding a positive short-term view on U.S. rates amid rising unemployment and decelerating inflation, which could see the 10-year yield drop below 4% in the coming weeks as participants focus on the potential for a lower Fed funds rate. Furthermore, a firmer tone in the U.S. may contribute to similar conditions in the European rates sector, even though the latter may have already rallied through fair value (hence our neutral short-term view on the asset class). We also hold a neutral short-term view of UK rates, which have also fallen on rising unemployment and weaker inflation.
- Considering the latest move, additional factors—such as the reduced headroom for the Fed to lift rates further (if needed) as well as the prior, extended time spent below current levels—could extend the rally. For example, the current 4-5% range is consistent with the early years of this century before the yield declined to sequentially lower lows. While we’re cognizant that the 10-year yield could temporarily return to the lower range, we believe it will be a short visit with the 10-year again returning to the 4-5% range once the rally’s momentum wanes.
- Elsewhere, we continue to see “weakflation” conditions in Europe with fiscal policy playing the wild card in terms of future growth. Indeed, the Stability Growth Pact will deactivate in 2024, and new European fiscal rules will come into force, but not with the intent of implementing austerity. Instead, we anticipate bespoke, country specific paths of up to seven years that could lead to gentle fiscal consolidation and glide paths to lower debt-to-GDP ratios.
DEVELOPED MARKET RATES
- The market is currently pricing in the first Fed rate cut in June 2024, which would be 11 months after the latest rate hike in July ’23. Historically, the Fed has taken an average of five months to pivot from hikes to cuts. Hence, Chair Powell’s comments this Friday (a day before the quiet period starts prior to the Dec. 13 FOMC decision) bear monitoring as will the Fed’s updates to its economic projections, which should see the ’23 dot drop at the very least of the updates.
- With the caveat that each cycle is different, the U.S. rates complex has tended to bull steepen during the months around a potential Fed pivot. For example, the 10-year yield has historically eased three to five months before the first cut, while the 5/30s curve has steepened around the time of the first cut, according to J.P. Morgan.
- The recent, sizable divergence between volatility measures also warrants monitoring. For instance, the accompanying chart of the VIX index shows little equity volatility recently in a clear separation from the MOVE index, which continues to show elevated volatility across the U.S. rates complex.
- Staying with the topic of volatility, agency MBS spreads widened by a handful of basis points last week on some opportunistic profit-taking early in the week. In terms of performance, thirty-year mid-stack coupons remain quite resilient and marginally outperformed the wing coupons. Some BWIC activity emerged in seasoned 30-year lower coupons, leading to some speculation that regional banks were selling. Fifteen-year MBS continue to lag the 30-year sector, and the 20-year sector continues to hold in quite well vs. both the 15- and 30-year.
IG CORPORATES
- While higher-beta BBBs continued to lead the U.S. market rally, last week's strength was driven by intermediate maturities (5-10 years). Spreads tightened in a number of industries, including banks (3-4 bps), regionals (5-15 bps), REITS (5 bps), energy (5-10 bps), and auto (10-15 bps).
- Technicals were supportive with ~$7B in new deals (4.2x oversubscribed with 9.3 bps of concessions). This week's supply is expected to tick up to $15B - $20B. Overseas demand was strong with ~$3B in paper sold, 80% of which was sold to overseas accounts likely due to investors seeking hedges as the Dollar index moved lower. In the short term, our outlook U.S. IG remains positive given the lack of supply in the coming weeks, overseas demand, high rates, etc.
- Last week, EUR IG cash spreads traded in a tight range, underperforming the U.S. Corp. index. Part of the underperformance can be attributed to a busy primary calendar in EUR with €11B of supply across the first three days of the week skewed towards corporates. Order books were healthy, covered > 3x on average, allowing deals to price with minimal concessions. This week, we expect the new issue market to be open (if market conditions remain benign) before slowing down as the year draws to a close.
HIGH YIELD
- U.S. high yield bond spreads tightened last week, and yields declined amid a muted week for new issuance. By quality, returns were positive across all credit tiers with BBs outperforming on an excess return basis. Decompression continued, with BBs now trading at their year-to-date tights, while Bs and CCCs are currently trading 20 bps and 100 bps wide of their year-to-date tights, respectively. Total returns were also positive across all high yield sectors, with paper (+1.00%), hotel (+0.82%), and cable (+0.79%) among the best performers.
- High yield bond funds posted weekly inflows of $325M, with ETFs accounting for $371M of the total and actively managed accounts accounting for -$46M. In the holiday-shortened week, there were no new issues. High yield issuance currently stands at $162.7B, or $56.8B ex-refinancing, so far in 2023. Following recent tightening, current spreads imply a 12-month default rate of just under 2%, according to JP Morgan. Given our expectation for default rates to rise higher than that, we believe spreads appear relatively tight.
- U.S. loans gained, with fund flows relatively muted for the week. New issuance was light and, barring a small flurry of deals over the coming week or so, we expect limited new issuance over the remainder of the year. Given upcoming seasonal paydowns, we anticipate meaningful uptick in cash balances that will need to be redeployed over the coming several weeks, which should provide a strong technical bid for loans going into year-end.
- In Europe, high yield bonds posted positive total returns, with CCCs outperforming. Secondary volumes were light, and there was just one new issue. Loans posted positive returns as four new deals priced. No CLOs priced and there was no BWIC activity.
EMERGING MARKETS
- EM hard-currency government bond spreads tightened last week, approaching the tights achieved in July, as the market is clearly pricing in a Fed pause and a softish landing. Technicals were also supportive as issuance was low and flows turned modestly positive. While IG, BBs, and Bs all performed somewhat similarly, CCCs and below were main drivers of last week's tightening. Argentina was up almost 19% in the wake of Milei's election amidst his pledge to implement fiscal reforms before dollarization.
- EM corporate spreads tightened, with high yield outperforming. China property bounced from the lows on reports suggesting the government has put together a list of developers eligible for bank funding. EM local markets took a breather as yields rose modestly. High yielders, such as Turkey, Mexico, South Africa, and Hungary, underperformed. Turkey surprised the market by hiking 500 bps to 40% (versus the 250 bps that was expected). We now believe rate normalization in Turkey is nearing its final stage, and there is very little upside left in being underweight.
- EMFX gained, with LatAm outperforming and MEA underperforming. USD continued to grind lower, but given the extent of the recent move, we don't expect to see much further downside without further relative repricing in rates.
Securitized Products
- CMBS U.S. 10-year conduit spreads rallied 3 bps to T+140 last week following the strength in the corporate market. Nevertheless, the basis between the two markets widened further, and CMBS AAA conduits continue to trade historically wide to corporates. A 5-year conduit deal and a 10-year conduit deal is in market this week, with the 10-year conduit deal talked at T+145. Agency CMBS tightened 2 bps. SASB AAA and mezzanine spreads were unchanged.
- RMBS spreads were relatively flat across sectors. Currently Low LTV CRT M1/M1A, M2/M1B, and B1 are trading SOFR+155/240/335, respectively. Non-QM and RPL AAAs are trading T+185 and T+150 respectively. In the primary market, one SFR deal priced last week, bringing year-to-date issuance to $65B. We expect a steep decline of gross RMBS issuance in 2023 ($60-$70B in 2023 vs $135B in 2022). Net supply is expected to remain positive, +$12B in 2023, due to slower prepays and muted deal redemptions.
- In CLOs, spreads were firmer, particularly in mezzanine tranches. We believe spreads for U.S. benchmark issuers are ~3M SOFR+170/240/290/460/785 for AAA/AA/A/BBB/BB, respectively. We anticipate the basis in manager tiering to persist at ~15-25 basis points into year-end. Given the recent rally, we have modestly reduced our short-term outlook given our view that the easiest path is to move marginally wider but remain positive over the longer-term given our believe AAA CLOs continue to offer strong relative value.
- ABS spreads were unchanged last week. We are positive on spreads over the near term as ABS has lagged the broader market rally over the last few weeks and the reduction of new issue volume into December should help dealers reduce inventory. Consumer fundamentals are resilient in aggregate, particularly prime cohorts. The effects of inflation and lower disposable income continue to weigh on weaker segments of consumer credit. Post-pandemic performance divergence is expected to continue, particularly within subprime ABS sectors, and we expect second-tier originators to continue to underperform.
Municipal Bonds
- In the municipal bond space, an empty primary calendar and $235M in inflows were the main drivers of muni performance. Inflows were primarily driven by ETFs. This week's supply is estimated to be over $8B. Despite lagging new issue supply in the first half of 2023 (down about 20% from the previous year), supply is expected to be comparable to 2022. A resurgence in taxable supply is not expected as the feasibility of refinancing remains unfavorable.
- Strong holiday sales should help buttress sales tax collection, especially as many states now have procedures in place to collect taxes from online sales (~8%). In addition, U.S. voters approved ~$57B to fund paving roads, building schools, and other local projects earlier in the month. This, coupled with pressure from federal aid leveling off and rising constructions cost, will likely cause state governments to issue new debt going forward.
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Source(s) of data (unless otherwise noted): PGIM Fixed Income as of November 2023
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U.S. Investment Grade Corporate Bonds: Bloomberg Barclays U.S. Corporate Bond Index: The Bloomberg Barclays U.S. Investment Grade Corporate Bond Index covers U.S.D-denominated, investment-grade, fixed-rate or step up, taxable securities sold by industrial, utility and financial issuers. It includes publicly issued U.S. corporate and foreign debentures and secured notes that meet specified maturity, liquidity, and quality requirements. Securities included in the index must have at least 1 year until final maturity and be rated investment-grade (Baa3/ BBB-/BBB-) or better using the middle rating of Moody’s, S&P, and Fitch.
European Investment Grade Corporate Bonds: Bloomberg Barclays European Corporate Bond Index (unhedged): The Bloomberg Barclays Euro-Aggregate: Corporates bond Index is a rules-based benchmark measuring investment grade, EUR denominated, fixed rate, and corporate only. Only bonds with a maturity of 1 year and above are eligible.
U.S. High Yield Bonds: ICE BofAML U.S. High Yield Index: The ICE BofAML U.S. High Yield Index covers US dollar denominated below investment grade corporate debt publicly issued in the US domestic market. Qualifying securities must have a below investment grade rating (based on an average of Moody’s, S&P and Fitch), at least 18 months to final maturity at the time of issuance, and at least one year remaining term to final maturity as of the rebalancing date.
European High Yield Bonds: ICE BofAML European Currency High Yield Index: This data represents the ICE BofAML Euro High Yield Index value, which tracks the performance of Euro denominated below investment grade corporate debt publicly issued in the euro domestic or eurobond markets. Qualifying securities must have a below investment grade rating (based on an average of Moody's, S&P, and Fitch). Qualifying securities must have at least one year remaining term to maturity, a fixed coupon schedule, and a minimum amount outstanding of €100 M. ICE Data Indices, LLC, used with permission. ICE DATA INDICES, LLC IS LICENSING THE ICE DATA INDICES AND RELATED DATA "AS IS," MAKES NO WARRANTIES REGARDING SAME, DOES NOT GUARANTEE THE SUITABILITY, QUALITY, ACCURACY, TIMELINESS, AND/OR COMPLETENESS OF THE ICE DATA INDICES OR ANY DATA INCLUDED IN, RELATED TO, OR DERIVED THEREFROM, ASSUMES NO LIABILITY IN CONNECTION WITH THEIR USE, AND DOES NOT SPONSOR, ENDORSE, OR RECOMMEND PGIM FIXED INCOME OR ANY OF ITS PRODUCTS OR SERVICES.
U.S. Senior Secured Loans: Credit Suisse Leveraged Loan Index: The Credit Suisse Leveraged Loan Index is a representative, unmanaged index of tradable, U.S. dollar denominated floating rate senior secured loans and is designed to mirror the investable universe of the U.S. dollar denominated leveraged loan market. The Index return does not reflect the impact of principal repayments in the current month.
European Senior Secured Loans: Credit Suisse Western European Leveraged Loan Index: All Denominations EUR hedged. The Index is a representative, unmanaged index of tradable, floating rate senior secured loans designed to mirror the investable universe of the European leveraged loan market. The Index return does not reflect the impact of principal repayments in the current month.
Emerging Markets U.S.D Sovereign Debt: JP Morgan Emerging Markets Bond Index Global Diversified: The Emerging Markets Bond Index Global Diversified (EMBI Global) tracks total returns for U.S.D-denominated debt instruments issued by emerging market sovereign and quasi-sovereign entities: Brady bonds, loans, and Eurobonds. It limits the weights of those index countries with larger debt stocks by only including specified portions of these countries’ eligible current face amounts of debt outstanding. To be deemed an emerging market by the EMBI Global Diversified Index, a country must be rated Baa1/BBB+ or below by Moody’s/S&P rating agencies. Information has been obtained from sources believed to be reliable, but J.P. Morgan does not warrant its completeness or accuracy. The Index is used with permission. The Index may not be copied, used, or distributed without J.P. Morgan's prior written approval. Copyright 2021, J.P. Morgan Chase & Co. All rights reserved.
Emerging Markets Local Debt (unhedged): JPMorgan Government Bond Index-Emerging Markets Global Diversified Index: The Government Bond Index-Emerging Markets Global Diversified Index (GBI-EM Global) tracks total returns for local currency bonds issued by emerging market governments.
Emerging Markets Corporate Bonds: JP Morgan Corporate Emerging Markets Bond Index Broad Diversified: The CEMBI tracks total returns of U.S. dollar-denominated debt instruments issued by corporate entities in Emerging Markets countries.
Emerging Markets Currencies: JP Morgan Emerging Local Markets Index Plus: The JP Morgan Emerging Local Markets Index Plus (JPM ELMI+) tracks total returns for local currency–denominated money market instruments.
Municipal Bonds: Bloomberg Barclays Municipal Bond Indices: The index covers the U.S.D-denominated long-term tax-exempt bond market. The index has four main sectors: state and local general obligation bonds, revenue bonds, insured bonds, and pre-refunded bonds. The bonds must be fixed-rate or step ups, have a dated date after Dec. 13, 1990, and must be at least 1 year from their maturity date. Non-credit enhanced bonds (municipal debt without a guarantee) must be rated investment grade (Baa3/BBB-/BBB- or better) by the middle rating of Moody's, S&P, and Fitch.
U.S. Treasury Bonds: Bloomberg Barclays U.S. Treasury Bond Index: The Bloomberg Barclays U.S. Treasury Index measures U.S. dollar-denominated, fixed-rate, nominal debt issued by the U.S. Treasury. Treasury bills are excluded by the maturity constraint but are part of a separate Short Treasury Index.
Mortgage Backed Securities: Bloomberg Barclays U.S. MBS - Agency Fixed Rate Index: The Bloomberg Barclays U.S. Mortgage Backed Securities (MBS) Index tracks agency mortgage backed pass-through securities (both fixed-rate and hybrid ARM) guaranteed by Ginnie Mae (GNMA), Fannie Mae (FNMA), and Freddie Mac (FHLMC). The index is constructed by grouping individual TBA-deliverable MBS pools into aggregates or generics based on program, coupon and vintage.
Commercial Mortgage-Backed Securities: Bloomberg Barclays CMBS: ERISA Eligible Index: The index measures the performance of investment-grade commercial mortgage-backed securities, which are classes of securities that represent interests in pools of commercial mortgages. The index includes only CMBS that are Employee Retirement Income Security Act of 1974, which will deem ERISA eligible the certificates with the first priority of principal repayment, as long as certain conditions are met, including the requirement that the certificates be rated in one of the three highest rating categories by Fitch, Inc., Moody’s Investors Services or Standard & Poor’s.
Palmer Square AAA CLO DM Index represents the discount margin of CLO AAA rated tranches in the Palmer Square CLO Senior Index, which is designed to reflect the investable universe of U.S CLO senior original rated AAA and AA debt issued after Jan 1, 2011.
Global Aggregate Bond Index is a measure of global investment grade debt from twenty four local currency markets. This multi-currency benchmark includes treasury, government-related, corporate and securitized fixed-rate bonds from both developed and emerging markets issuers.
U.S. Aggregate Bond Index: Bloomberg Barclays U.S. Aggregate Bond Index: The Bloomberg Barclays U.S. Aggregate Index covers the U.S.D-denominated, investment-grade, fixed-rate or step up, taxable bond market of SEC-registered securities and includes bonds from the Treasury, Government-Related, Corporate, MBS (agency fixed-rate and hybrid ARM passthroughs), ABS, and CMBS sectors. Securities included in the index must have at least 1 year until final maturity and be rated investment-grade (Baa3/ BBB-/BBB-) or better using the middle rating of Moody’s, S&P, and Fitch.
Euro Aggregate Bond Index is a broad-based flagship benchmark that measures the investment grade, euro-denominated, fixed rate bond market, including treasuries, government-related, corporate and securitized issues. Inclusion is based on currency denomination of a bond and not country of risk of the issuer.
Japanese Aggregate Bond Index The Japanese Aggregate Index contains fixed-rate investment-grade securities denominated in Japanese yen and registered as domestic bonds. The index is composed primarily of local currency sovereign debt but also includes government-related, corporate, and securitized bonds.
The S&P 500® is widely regarded as the best single gauge of large-cap U.S. equities. There is over U.S.D 9.9 trillion indexed or benchmarked to the index, with indexed assets comprising approximately U.S.D 3.4 trillion of this total. The index includes 500 leading companies and captures approximately 80% coverage of available market capitalization.
The DAX Index is a total return index of 30 selected German blue chip stocks traded on the Frankfurt Stock Exchange. The equities use free float shares in the index calculation. The DAX has a base value of 1,000 as of December 31, 1987. As of June 18, 1999 only XETRA equity prices are used to calculate all DAX indices.
The STOXX 600 Index is derived from the STOXX Europe Total Market Index (TMI) and is a subset of the STOXX Global 1800 Index. With a fixed number of 600 components, the STOXX Europe 600 Index represents large, mid and small capitalization companies across 17 countries of the European region.
The Nikkei 225 Index is a price-weighted average of 225 top-rated Japanese companies listed in the First Section of the Tokyo Stock Exchange. The Nikkei Stock Average was first published on May 16, 1949.
Shanghai Composite Index is a capitalization-weighted index. The index tracks the daily price performance of all A-shares and B-shares listed on the Shanghai Stock Exchange. The index was developed on December 19, 1990.
MSCI ACWI is a free-float weighted equity index. It was developed with a base value of 100 as of December 31 1987. MXWD includes both emerging and developed world markets.
FTSE 100 is a capitalization-weighted index of the 100 most highly capitalized companies traded on the London Stock Exchange. The equities use an investibility weighting in the index calculation. The index was developed with a base level of 1000 as of December 30, 1983.
MOVE Index is a yield curve weighted index of the normalized implied volatility on 1-month Treasury options. It is the weighted average of volatilities on the CT2, CT5, CT10, and CT30. (weighted average of 1m2y, 1m5y, 1m10y and 1m30y Treasury implied vols with weights 0.2/0.2/0.4/0.2, respectively).
VIX Index is a financial benchmark designed to be an up-to-the-minute market estimate of the expected volatility of the S&P 500® Index, and is calculated by using the midpoint of real-time S&P 500 Index (SPX) option bid/ask quotes.
Bloomberg Commodity Index Bloomberg Commodity Index (BCOM) is calculated on an excess return basis and reflects commodity futures price movements. The index rebalances annually weighted 2/3 by trading volume and 1/3 by world production and weight-caps are applied at the commodity, sector and group level for diversification. Roll period typically occurs from 6th-10th business day based on the roll schedule.
The U.S. Dollar Index indicates the general international value of the USD. The USDX does this by averaging the exchange rates between the USD and major world currencies. The ICE US computes this by using the rates supplied by some 500 banks.
2023-8727
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