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by  BlueBay Fixed Income team, S.Fitzsimmons Sep 19, 2023

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Economic data and new bond issuance have been elevated recently. The recent CPI data showed that inflation remains stubborn. The market didn’t have much of a reaction to the news and looks to this week’s FOMC meeting for direction on rates. Meanwhile, We’ve experienced a significant supply of new issuance of investment grade and high yield bonds.

  • Recent inflation has been slightly above expectation driven by energy prices.
  • The market reaction to the CPI news has been muted.
  • We await any rate decision from the FOMC meeting this week and the language used to describe their thinking will warrant close scrutiny.
  • We’ve recently experienced a heavy dose of new bond issuance.
  • To us, this indicates the market expects a soft landing and that credit fundamentals remain strong.

View transcript

Good afternoon and welcome to the Weekly Fix, my name is Stephen Fitzsimmons, BlueBay Institutional Portfolio Manager with RBC Global Asset Management’s US Fixed Income team in Stamford, Connecticut.

Economic data and new issue flows have been elevated over the past week… and this week we expect more of the same. As such, we think for today’s edition of the weekly fix, it makes sense to spend some time talking about market reactions to these important dynamics and what the desk is preparing for in the week ahead.

The month-over-month headline consumer price index increased 0.6% for August, in line with expectations. The core consumer price index, that excludes food and energy, rose 0.3% month-over-month against expectations of 0.2%. Much of the gain in headline inflation is due to an increase in energy prices. In core inflation, housing continues to be an outsized contributor to the index. It is important to note that although this is the largest increase in CPI year-to-date, market participants’ inflation expectations have fallen to the lowest levels we have seen in over two years.

On the week, rates rose mildly across the curve with the two-year Treasury leading the way increasing 8 basis points to end the week at 5.07%. This had the effect of further inverting the 2s10s curve by nearly 2 basis points and the 2s30s by a similar magnitude. The S&P 500 ended the week marginally lower and investment grade credit spreads closed the week 1 basis point tighter to 124 basis points. This indicates a fairly banal market reaction to the CPI news.

Fed dot plots and market participants do not expect a rate increase at the FOMC meeting on Wednesday this week. However, it will be important to read through the rate decision itself and decompose the language Powell uses here, searching for dovish or hawkish verbiage, which can help indicate whether or not the Fed is prepared to increase or decrease rates at later meetings this year. Any such language could provide important insight into the path of inflation and the shape of the yield curve for the months ahead.

Now, to shift gears toward new issuance in the U.S. corporate bond market - last week we saw over 30 billion dollars of U.S. investment grade new issuance and just over 8 billion dollars of U.S. high yield new issuance. Projections indicate another 15-20 billion dollars in new issue this week. We expect this supply to be front-loaded early in the week with things slowing down by Wednesday for the FOMC rate decision. Monday morning alone, we saw somewhere in the ballpark of nine high-grade issuers come to market.

Coming out of the typically slow summer season, markets are digesting this large influx of new issuance quite well. Typically, investors could expect some level of spread premium in purchasing bonds in the new issue market. Interestingly, these spread premiums have evaporated against this deluge of supply over the past couple of weeks with primary bonds coming at levels on top of those outstanding in the secondary market. To us, this indicates a credit market that is highly expectant of a soft landing into the later stages of this cycle and that market participants feel credit fundamentals remain strong. It also suggests that although spreads are relatively snug, investors feel that all-in yields still show value toward a compelling carry trade. Fundamentally speaking, year to date upgrades in the investment grade credit market have outpaced downgrades 100 to 82, and although downgrades outpace upgrades in the high yield bond market, interest coverage ratios and companies’ profitability remain high relative to historical averages in this space – this further suggesting credit strength.

We remain judicious in seeking relative value and fundamental strength in deals we participate in both the new issue market and in secondary trading. Dynamism in an active approach will be critically important in the months ahead as dispersion in the views of both fed officials and market participants remain elevated and potential investment outcomes highly varied. We thank you for tuning into this edition of the weekly fix and wish you a successful trading week. Be well everyone.

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