A "quiet" week in fixed income

This week we saw the largest fiscal stimulus in U.S. history, significant monetary policy announcements from the Fed and T-bills go into negative yielding territory… and it felt like a quiet week!

Macro-level recap

  • The Fed announced on March 23 (it feels like a lifetime ago) a massive expansion of policy,  notably expanding quantitative easing (QE) from $700 billion (announced only a week earlier) to “the amount needed”, introducing two facilities to purchase corporate bonds, and initiating facilities to support asset backed securities, CP and money markets.
  • The U.S. also passed a much anticipated $2 trillion fiscal stimulus package. The massive stimulus (more than two times the 2008 package), is intended to offset the expected contraction in demand from corporates and consumers. 
  • Initial jobless claims spiked from 280,000 last week to a record high 3.2 million this week (and they’re still going up).
  • With its ongoing efforts to support markets, the Fed balance sheet expanded to greater than $5 trillion for the first time. The liquidity provided seems to be making its way through the system with the dollar broadly lower on the week and measures of funding stress (repo, cross-currency basis) normalizing.

U.S. Treasuries & Credit

  • The increase in fiscal spending will cause a spike in Treasury issuance. Despite Fed purchases (estimated to be about $1.5 trillion through the end of 2020), the market will need to absorb a significant amount of additional supply. The T-bill market is likely to see the bulk of issuance which should help alleviate some of the shortage of front end paper where T-bills traded at negative yields out to 6 month maturities.
  • CDX (credit derivative measure) traded better than cash, reflecting cash shortage in markets. Those with capital to allocate can continue to drive pricing.
  • Front-end U.S. credit remains a large dislocation, with significant inversion of short paper vs. long paper.  Within capital structures we continue to see dislocation between fixed and floating rate (IG) further demonstrating that market stress remains.
  • Bonds eligible for Fed program have outperformed non-eligible bonds significantly, tightening by 50 basis points (bps) more. Historically, initial moves tend to be overdone.
  • Liquidity has been a bit of a conundrum. Secondary market liquidity remains poor, but improved. However, record new issuance occurring at the same time ($99 billion in new IG issuance as of March 26) sets a record as does the $198 billion in IG supply month-to-date (prior record was $177 billion in May 2016).  Year to date, issuance volume is +37% year over year.
  • The U.S. team participated in several new issues this week, but did not receive full allocation. Over-subscription shows some signs of improvement in the market.
  • Ratings agencies continue to be very active with several high profile downgrades recently (F, OXY, DAL) bringing the YTD fallen angel count to 15.
  • The weeks ending March 13 and March 20 were the worst for U.S. corporates on both a spread and total return basis, but the week ending March 27 was the best for U.S. corporates on both a spread and total return basis.
  • Even with this tightening, OAS (option adjusted spreads) remains at levels experienced less than 1% of the time going back to 2000.

U.S. Tax-exempt

  • Speed of both the backup and recovery of municipal (muni) rates is unprecedented: re-steepening of the BVAL muni yield curve has occurred this week, with the front end lower by approximately 165 bps (1.17%) week over week and yields for the 30 year tenor lower by 141 bps (2.00%) as of mid-day Friday 27 March.
  • Broad muni index, the Bloomberg Barclays Muni Bond Index, is now -0.81% YTD through March 26 vs. -7.62% to begin the week.
  • Through March 26, state and local 10 year GOs now yielding approximately 180% of UST vs. 214% one week prior.
  • Mid-week, 20 to 30 year AA tax-exempt municipals were yielding more than both like-rated taxable munis and corporates. This dislocation largely evaporated as crossover buyers stepped in on Wednesday and Thursday.
  • Higher grade GOs have recovered the most this week, with spread product, especially within sectors most reliant on a functioning consumer economy like airports, toll roads, hospitals and higher education, lagging. We are hopeful that the record U.S. stimulus package working its way through Congress will help to serve as a near-term backstop for many of these sectors.
  • Primary market volumes remain limited, but with yields back to March 12 levels, we would expect issuance to re-accelerate beginning next week.
  • Industry flows remain a headwind.  Per Lipper, for the week ending March 25, municipal bond funds & ETFs experienced a record $13.7 Billion outflow, surpassing last week’s then record $12.2 Billion  Encouragingly, high yield outflows slowed week/week, which should take some pressure off lower investment grade credits, as forced selling by some high yield managers abates. Quarter-end re-balancing activity may put additional pressure on flows in the near term.

Emerging Market Debt

  • Emerging market (EM) hard currency spreads reached 711bps on March 24, the highest since the financial crisis. They have since tightened about 100 bps as the market recovery in the second half of the week ending March 27, but still remain at an attractive level for investors with a long-term horizon.
  • Liquidity is still challenging but much improved compared to last week.
  • Panama came to the market with a new issue, a 35 year USD bond; this is the first EM deal to come post sell off.
  • According to JPM data, EM bond flows were -$11.8 billion over the last week, improved from ‑$14.6 billion the previous week.

EMEA Credit

  • The big theme has been around liquidity. This seems to be improving day on day, largely driven by Fed action and a little positivity coming back into the market, but we’re still seeing a lot of instances where bids are not aligning to screen values.
  • We’ve seen & have participated in some new issues coming to market this week where companies are taking advantage of current market conditions and these are now starting to perform quite well in the secondary market.
  • As in the U.S, unprecedented level of defaults being priced into spreads, portfolio activity is focused on single name research to identify which names are most likely to actually default.
  • Energy being hit particularly hard; this is true globally.
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Disclosures

The Bloomberg Barclays Municipal Bond Index is considered representative of the broad market for investment grade, tax-exempt bonds with a maturity of at least one year. Investments cannot be made in an index. The option-adjusted spread (OAS) is the measurement of the spread of a fixed-income security rate and the risk-free rate of return, which is adjusted to take into account an embedded option. Basis points (bps) represent 1/100th of a percent (for example: 50 bps equals 0.50%).

Views and opinions have been arrived at by BMO Global Asset Management. The information, estimates or forecasts provided were obtained from sources reasonably deemed to be reliable but are subject to change at any time. This publication is prepared for general information only; it should not be construed as investment advice or relied upon in making an investment decision. All investments involve risk, including the loss of principal. Past performance is not a guarantee of future results.

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