By Castleton Partners
Fixed income markets were able to register mild price gains last week, as market attention shifted from geopolitical concerns to economic data and the future direction of the Federal Reserve’s interest rate policy. Fueled by a surprisingly disappointing durable goods report, intermediate and long dated Treasuries recorded the largest yield declines, with 10y and 30y yields falling by 3 and 5 basis points respectively, to yield a 2.72% and 3.55%. As the first quarter of 2014 comes to a close, most economists have reduced their GDP forecasts for the quarter to 1.5%, a noticeable reduction from the 2.6% achieved during the 4th quarter of 2013.
As we look ahead to a new quarter, we are mindful of the fact that interest rate policy is data dependent and NOT calendar based. Thus, we expect increased volatility in the weeks and months ahead around key economic releases- especially this week and Friday’s payroll number. Castleton expects growth to remain uneven and below trend over the next quarter, as the burden of increased health care costs and high heating bills from an unusually harsh winter continue to crimp spending by an already strained consumer. Lest we forget, the Federal Reserve does have dual mandates of full employment and low inflation. Though the unemployment rate has been trending lower over the last 6 months, inflation, as measured by both the Consumer Price Index (CPI) and Personal Consumption Expenditure (PCE), remains well below the Fed’s target.
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Tax exempt performance was mixed last week, with intermediate and long maturities registering the largest yield declines. Continuing a quarter long trend, 10y and 30y high grade muni yields declined another 5 and 10 basis points respectively, to yield a 2.47% and 3.63%, modestly outperforming their taxable counterparts. With only one day left in the quarter, the $3.7 trillion tax exempt market is off to its strongest start in five years, erasing the losses recorded in 2013. Fueled by resurgence in demand and anemic supply, tax exempts have returned +3.35% year to date, as measured by the Barclays Municipal Bond Index. After recording over $60 billion of mutual fund withdrawals in 2013, fund flows have rebounded to +$2.1 billion so far in 2013, while supply is nearly 30% lower over the same period from a year ago.
Supply this week is expected to be a modest $4 billion, well below the 2014 weekly average of $5.4 billion. Heavily weighted towards high quality education issuers, the largest transactions are a $970mm sale for the University Of California Board Of Regents (Aa2/AA), $270mm for the University of Texas (Aaa/AAA), and $220mm for the University of Connecticut (Aa3/AA). Of those three institutions, only Connecticut has reached the Final Four of the NCAA men’s basketball tournament….
AAA Municipal Market Data (MMD) Yield Curve
Weekly Municipal Mutual Fund Flow Data
Investment grade corporate bond spreads continued their month long grind tighter last week, with spreads, on average, contacting another 1-2 basis points versus Treasuries. In rather impressive fashion, corporate spreads are at their tightest levels of 2014 despite significantly lower Treasury yields, subpar domestic growth, and rising geopolitical concerns. When factoring in that another $17 billion of new issue debt was priced last week, raising March’s totals to over $136 billion, the performance of high grade corporate bonds is even more impressive.
For only the second time over the last six weeks, financials dominated issuance last week, accounting for nearly 80% of supply. Receiving a favorable review from the recently released “stress test” conducted by the Federal Reserve, Bank of America was the largest issuer last week with a new multi tranche $7.6 billion dollar loan. Rated Baa2/A-, the largest maturity was a new $2.75b ten year note priced at +137bp over comparable maturity US Treasuries. Looking to take advantage of low long dated interest rates and a flatter yield curve of late, 47.9% of last week’s supply was ten years or longer.
As we enter the second quarter of 2014, the technical backdrop for investment grade debt remains supportive for spreads in the near term. Over $31 billion of high grade debt, all with original maturities of 18 months or longer, are expected to mature during the month of April, with most of that occurring in the next two weeks.
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