Fixed Income Market Comments

Transcription

1 Strategy Fixed Income Weekly Fixed Income Market Comments Yields moved higher last week as the final reading of second quarter economic growth (GDP) was higher than expected at 3.9% (forecast at 3.7%) and Fed Chair Janet Yellen s comments in a speech at UMass that a rate hike by the Fed this year remains on the table sent note and bond yields higher. Economic data on consumer activity and new home sales were good but durable goods order fell in August. Initial jobless claims were lower than expected at 267,000 for the week but slightly higher than expected. One would have thought that comments from Ms. Yellen along with hawkish comments from New York Fed President William Dudley and San Francisco Fed President John Williams along with the strong GDP report would have sent yields considerably higher but turmoil in the equity markets has dampened the yield rally in bonds. Yields on the short-end of the curve (T-bills) fell last week while the rest of the curve (notes and bonds) saw slightly higher yields. The yield on the benchmark 10-year Treasury note rose three basis points (bps) to 2.16% while the yield on the two-year Treasury note was up one bps to 0.69%, creating a 2s/10s spread of 147 bps (slope of the yield curve). The yield on the 30-year bond was also slightly higher up two bps to 2.96% (see the Treasury yield curve from Bloomberg that follows). Treasury Yield Curve Source: Bloomberg B. Craig Elder, Director Fixed Income Senior Analyst celder@rwbaird.com

2 Fixed income sector yields were higher last week with the exception of municipal bonds which fell four bps to 2.22%. The yield level on high yield bonds spiked higher by 38 bps to 7.68% as volatility in below investment-grade seems to be here to stay for the next few months (at a minimum) as problems in the energy sector continue. CreditSights is reporting that the fall bank line of credit (LOC) redeterminations for energy companies are not going well. Spread levels were slightly wider with the exception of high yield which was 33 bps higher last week to 590 bps over comparable Treasury yields (see the tables with data from the Barclay s Indices that follow). High yield spreads have moved 54 bps wider in just the past two weeks. Fixed Income Sector Spreads Sector 1/2/09 1/4/10 1/3/11 1/3/12 1/2/13 1/2/14 1/2/15 9/18/15 9/25/15 Aggregate Agencies MBS Corporates High Yield 1, Source: Barclay s Fixed Income Sector Yields Sector 1/2/09 1/4/10 1/3/11 1/3/12 1/2/13 1/2/14 1/2/15 9/18/15 9/25/15 Aggregate 4.23% 3.68% 3.01% 2.28% 1.79% 2.50% 2.23% 2.33% 2.37% Treasuries 1.72% 2.46% 1.92% 1.08% 0.90% 1.45% 1.42% 1.43% 1.44% Agencies 2.52% 2.27% 1.68% 1.26% 1.07% 1.69% 1.80% 1.67% 1.70% MBS 3.96% 4.14% 3.70% 2.68% 2.27% 3.27% 2.56% 2.62% 2.69% Municipals 4.52% 3.63% 3.80% 2.82% 2.19% 3.15% 2.07% 2.26% 2.22% Municipals 6.95%* 5.58%* 5.85%* 4.34%* 3.63%** 5.22%** 3.43%** 3.80%** 3.74%** Corporates 7.67% 4.73% 4.04% 3.80% 2.74% 3.26% 3.10% 3.39% 3.44% High Yield 19.40% 9.00% 7.38% 8.14% 5.96% 5.62% 6.63% 7.30% 7.68% Source: Barclay s *Based on 35.0% top Federal Tax Rate **Based on 39.6% top Federal Tax Rate Economic Highlights Previous Week The Bureau of Economic Analysis (BEA) at the Commerce Department reported last week that second quarter GDP grew at a robust 3.9% rate, up significantly from the anemic 0.6% growth in the first quarter. Expectations are for third quarter GDP growth to be in the 2.0%-3.0% range (the Atlanta Fed GDPNow model discussed below is forecasting growth of 1.8%). We will get the first read on third quarter GDP in late October. The BEA said that acceleration in GDP growth during the quarter reflected an upturn in exports (despite strength in the dollar), an acceleration in PCE, a deceleration in imports, an upturn in state and local government spending, and an acceleration in nonresidential fixed investment that were partly offset by decelerations in private inventory investment and in federal government spending. Durable Goods Orders fell by 2.0%, slightly less than the 2.3% forecasted decline, in August while Durable Goods less Transportation were flat, below expectations of growth of 0.1%, in data released by the Census Bureau last week.

3 New Home Sales rose 5.7% to 552,000 in August which was up from the revised July number of 522,000 (originally reported as 507,000) and higher than expectations of growth of 515,000, according to data from the Commerce Department. This was a seven-year high as interest rate levels remain low enough for home buyers to get into homes. The median new home price was up 0.3% to $292,700. We note that some economist believe the New Home Sales data is a better measure of housing activity because the data is more timely. New Home Sales data is captured at time of the contract signing while Existing Home Sales are captured at the closing of the sale (normally a month or two later). Other economic data that were reported included Personal Income for August that grew 0.3% (less than the forecast growth of 0.4% however, July income growth was revised to 0.5% from the first reported 0.4%) while spending rose 0.4% (higher than the forecast of 0.3% matching the revised 0.4% level seen in July). For you data nerds, Personal Income for the month was $52.5 billion while Personal Spending was $54.9 billion. Included in the Income and Spending release was the inflation report, Personal Consumption Expenditures (PCE) core (excluding food and energy) year-over-year that grew to % in August (see chart from the BEA and Bloomberg that follows) from the July level of % (both are reported as 1.3%). This is another measure of inflation that remains well below the Fed s 2.0% inflation target although there it was a tad higher than in July. Personal Consumption Expenditure Core Year-over-Year Sources: BEA and Bloomberg Economic Highlights This Week This week is employment report week with expectations of job creation in September of 198,000 jobs. Last month only 173,000 jobs were created but there were revisions of the July and June numbers higher. The unemployment rate (BLS U- 3 measure) is expected to remain at the 5.1% rate, average hourly earnings are expected to increase by 0.2% (2.4% yearover-year) and average weekly hours are expected to be stable at Other employment data in the report are the underemployment rate (BLS U-6 measure) that was 10.3% and the Labor Participation rate which was 62.6% in August.

4 A couple of additional economic data the markets will take into consideration this week include the ISM Manufacturing report for September which is expected to fall to 50.6 from 51.1 in August and Factory Orders for August are expected to fall 1.2%. GDPNow Model Forecast for 3 rd Quarter GDP The Atlanta Fed said that its GDPNow model forecast for real GDP growth in the third quarter of 2015 is 1.8% as of September 28, up from 1.4% on September 24. The model's forecast of the growth rate of real personal consumption expenditures in the third quarter increased from 3.2% to 3.5% after the report on personal income and outlays from the U.S. Bureau of Economic Analysis (BEA). Corporate Bond Market Comments Investment-grade spreads finished the week three bps wider at 163 bps over comparable Treasury yields while high yield spreads were wider by 33 bps to the 590 bps level. So far this year investment-grade spreads are 32 bps wider while high yield spreads are 102 bps wider. High yield energy spreads, at 968 bps over comparable Treasury yields, are 231 bps wider so far this year, according to data from Barclay s. Investment-grade financials are 23 bps wider this year at 141 bps, Industrials are 38 bps wider at 176 bps and utilities are 29 bps wider for the year at 150 bps over comparable Treasury yields, according to data from the Barclay s Indices. Investment-grade corporate debt has a negative total return of 0.29% year-to-date while high-yield debt has a negative 1.24% total return as energy (about 15% of the high yield index) has a negative total return of 10.37% year-to-date (even a 6.73% average coupon has not offset the price declines in the sector that have fallen to an average of $78.12), according to data from Barclay s. Preferred stock issues have a total return this year of 4.63% while leveraged loans have a total return of 2.59%, according to data from BofA Merrill Lynch.

5 Investment grade bond supply for last week was estimated at $24.5 billion which was an improvement of the $11.8 billion of issuance the week ended the 18 th but well below the $48 billion that was issued the first full week in September. Much of the issuance was in the financial sector with the large banks coming to market with deals. High yield issuance was a healthy $11.3 billion despite the volatility in the high yield market place. Oil & Gas Bank Redetermination Season is Upon Us Many Stockings will be Filled with Coal Banks are in process of conducting their semi-annual redetermination of lines of credit they supply oil & gas companies, and it is not going to be pretty. We normally would not care much about these redeterminations but the impact on the overall corporate bond default rates forces us to look at the situation. CreditSights recently published a report on the fall redetermination process. In the report they said that it looks painful as in an environment where oil & gas prices have fallen approximately 15% since the spring redeterminations, the bank regulators are pressuring the banks on their energy lending activity, and hedge books are rolling off could result in the energy default rate rising to higher levels than they previously thought. While the two-year CreditSights default rate estimate for 2015 and 2016 is 8%, they said that with 2015 already running close to 10% and access to capital dwindling, their estimate may look low at the end of the day. There are a couple of key points that the article notes. First, to the surprise of no one, the lower rated companies (single-b and triple CCC s) will likely be negatively impacted the most by the redeterminations as they tend to be smaller operators with more leverage needing the bank LOC s to remain in operation as the capital markets are effectively closed to these companies. Borrowing reductions could be as high as $12 billion (10-15% reduction from the current levels). The second item of note is the aggressiveness of the banking regulators in pressuring the banks to pull back their lending to the energy companies. CreditSights blames this on the regulators nervousness over the lower asset values of oil & gas and stretched energy company balance sheets as they want to avoid an outcome similar to the 1980 s oil bust that essentially destroyed the Savings & Loan (S&L) industry. CreditSights analysts note that regulators seem to be ignoring that reserve-based energy lending has experienced an excellent track record for over two decades with almost a 100% recovery rate. They add that their bank team has calculated that energy lending is less than 5% of the largest banks loan books. One conclusion is that that the objective of the bank regulators could be to speed up the inevitable restructuring process rather than drawing it out over the next five or so years.

6 Single A Investment-Grade Yield Curve Source: Bloomberg Composite Single A Corporate Bond Yield Curve Single B- B B+ Speculative-Grade Yield Curve Source: Bloomberg Composite B Corporate Bond Yield Curve

7 Historical Spread Levels for High Yield Bonds Sources: BofA Merrill Lynch and the St. Louis Federal Reserve Sources: Atlanta Fed GDPNow Model: Latest Forecast. September 28, BofA Merrill Lynch: BofA Merrill Lynch US High Yield Master II Option Adjusted Spread (retrieved from FRED Federal Reserve Bank of St. Louis. September 25, Barclay s Indices Bureau of Economic Analysis: Personal Income and Outlays: August Bloomberg Charts Bloomberg News Bloomberg Economic Releases CreditSights: Monday Morning Notes: Week Ended September 25, CreditSights: Oil & Gas: Bank Redeterminations Look Painful. September 27, U.S. Census Bureau: Advance Report on Durable Goods Manufacturer s Shipments, Inventories and Orders August September 24, 2015.

8 Economic Calendar DATE TIME INDICATOR CONSENSUS PREV. REPORT 9/28 08:30 Personal Income 0.4% 0.4% 9/28 08:30 Personal Spending 0.3% 0.3% 9/28 08:30 PCE Deflator (MoM) 0.0% 0.1% 9/29 08:30 PCE Deflator (YoY) 0.3% 0.3% 9/28 08:30 PCE Core (MoM) 0.1% 0.1% 9/28 08:30 PCE Core (YoY) 1.3% 1.2% 9/28 10:00 Pending Home Sales 0.4% 0.5% 9/28 10:00 Pending Home Sales NSA (YoY) 8.1% 7.2% 9/29 10:00 Consumer Confidence Index /30 08:15 ADP Employment Change 190K 190K 9/30 09:00 ISM Milwaukee /30 09:45 Chicago Purchasing Manager /1 08:30 Initial Jobless Claims 271K 267K 10/1 08:30 Continuing Claims 2230K 2242K 10/1 10:00 Construction Spending (MoM) 0.5% 0.7% 10/1 10:00 ISM Mfg /1 10:00 ISM Prices Paid /1 -- Wards Domestic Vehicle Sales 13.80m 13.80m 10/1 -- Wards Total Vehicle Sales 17.60m 17.72m 10/2 08:30 Change in Nonfarm Payrolls 202K 173K 10/2 08:30 Change in Private Payrolls 198K 140K 10/2 08:30 Unemployment Rate 5.1% 5.1% 10/2 08:30 Average Hourly Earnings (MoM) 0.2% 0.3% 10/2 08:30 Average Hourly Earnings (YoY) 2.4% 2.2% 10/2 10:00 Factory Orders -1.3% 0.4% Sources: Bloomberg Financing Calendar DATE TERM APPROX. YIELD AMOUNT 9/28/15 3-Month 0.01 $18 9/28/15 6-Month 0.08 $18 Sources: Bloomberg

9 Treasury Yield Sources: Bloomberg For more information please contact your Financial Advisor.

10 Municipal Yield Curve General Obligations - Yields as of 09/25/15 Time (Yrs) Year "AAA" Pre-re Insured "AA" "A" "BAA" Muncipal Yield Curves (AAA, AA, A) Yield "AAA" "AA" "A" Years Please note that these levels are representative of institutional net levels, and do not reflect retail sales credit. These yields should be used as general market indicators only. Source: Municipal Market Data

11 SUMMARY OF KEY FIXED INCOME MARKET INFORMATION WEEK ENDING : 9/25/2015 TODAY WEEK AGO MONTH AGO YEAR AGO BOND BUYER REVENUE INDEX 4.10% 4.18% 4.20% 4.78% BOND BUYER 20-BOND INDEX 3.71% 3.78% 3.79% 4.11% BOND BUYER 11-BOND INDEX 3.23% 3.30% 3.31% 3.96% REPRESENTATIVE MUNICIPAL BOND YIELDS (Source: Bloomberg) AAA RATED G.O.s 2 Year 0.60% 0.65% 0.58% 0.37% 5 Year 1.34% 1.46% 1.38% 1.20% 10 Year 2.13% 2.31% 2.23% 2.25% 15 Year 2.57% 2.76% 2.67% 2.70% 30 Year 3.26% 3.24% 3.13% 3.24% PRIME RATE (Source: Bloomberg) 3.25% 3.25% 3.25% 3.25% DISCOUNT RATE (Source: Bloomberg) 0.75% 0.75% 0.75% 0.75% FEDERAL FDS AVG (Source: Bloomberg) 0.25% 0.25% 0.25% 0.25% COMMERCIAL PAPER 30 Day 0.17% na 0.10% 0.06% {PRIME ISSUERS} 60 Day 0.25% na 0.25% 0.09% Bond Equivalent Yield 90 Day 0.29% na 0.30% 0.12% (Source: Bloomberg) AGENCY DISCOUNT NOTES * 30 Day 0.06% na 0.05% 0.005% Bond Equivalent Yield 60 Day 0.09% na 0.10% 0.005% 90 Day 0.14% na 0.15% 0.01% TAXABLE 7-DAY FLOATER 0.35% 0.36% 0.35% 0.30% (Source: ) TAX FREE 7-DAY FLOATER Non-AMT 0.02% 0.02% 0.02% 0.04% (Source: ) AMT 0.24% 0.24% 0.24% 0.26% U.S. TREASURY BILLS 3 Month -0.02% 0.01% 0.05% 0.01% Bond Equivalent Yield 6 Month 0.06% 0.11% 0.20% 0.03% (Source: Bloomberg) GOVERNMENTS 2 Year 0.70% 0.67% 0.69% 0.56% (Source: Bloomberg) 5 Year 1.47% 1.45% 1.49% 1.76% 10 Year 2.15% 2.16% 2.16% 2.50% 30 Year 2.93% 2.98% 2.90% 3.21% CORPORATE A FINANCE YIELDS (Source: Bloomberg) 2 Year 1.55% 1.56% 1.55% 1.11% 5 Year 2.65% 2.67% 2.70% 2.38% 10 Year 3.69% 3.71% 3.76% 3.59% 30 Year 4.65% 4.66% 4.65% 4.59% CORPORATE A UTILITY YIELDS (Source: Bloomberg) 2 Year 1.44% 1.44% 1.46% 1.05% 5 Year 2.52% 2.53% 2.51% 2.21% 10 Year 3.48% 3.52% 3.47% 3.23% 30 Year 4.37% 4.47% 4.37% 4.18% CORPORATE A INDUSTRIAL YIELDS (Source: Bloomberg) 2 Year 1.22% 1.22% 1.23% 0.94% 5 Year 2.37% 2.38% 2.38% 2.11% 10 Year 3.41% 3.43% 3.43% 3.27% 30 Year 4.32% 4.38% 4.36% 4.22% CDs 1 Year 0.65% 0.65% 0.75% 0.55% (Source: ) 2 Year 1.25% 1.25% 1.30% 1.00% 5 Year 2.30% 2.30% 2.30% 2.15% 10 Year 2.90% 2.90% 2.90% 3.30% * Yields presented represent the prevailing market price as of 9/24/2015 and are not representative of a specific issue.

12 Appendix Important Disclosures Some of the potential risks associated with fixed income investments include call risk, reinvestment risk, default risk and inflation risk. Additionally, it is important that an investor is familiar with the inverse relationship between a bond s price and its yield. Bond prices will fall as interest rates rise and vice versa. When considering a potential investment, investors should compare the credit qualities of available bond issues before they invest. The two most recognized rating agencies that assign credit ratings to bond issuers are Moody's Investors Service ( Moody s ) and Standard & Poor's Corporation ( S&P ). Moody s lowest investment-grade rating for a bond is Baa3 and S&P s lowest investment-grade rating for a bond is BBB-. This is not a complete analysis of every material fact regarding any sector, municipality or security. The opinions expressed here reflect our judgment at this date and are subject to change. The information has been obtained from sources we consider to be reliable, but we cannot guarantee the accuracy. It is strongly recommended that an investor discuss with their financial professional all materially important information such as risks, ratings and tax implications prior to making an investment. Past performance is not a guarantee of future results. This report does not provide recipients with information or advice that is sufficient on which to base an investment decision. This report does not take into account the specific investment objectives, financial situation, or need of any particular client and may not be suitable for all types of investors. Recipients should consider the contents of this report as a single factor in making an investment decision. Additional fundamental and other analyses would be required to make an investment decision about any individual security identified in this report. ADDITIONAL INFORMATION ON SECURITIES MENTIONED HEREIN IS AVAILABLE UPON REQUEST BY CONTACTING YOUR BAIRD INVESTMENT PROFESSIONAL. Copyright 2015 Incorporated.