![](/sites/default/files/styles/1086x410/public/Nuveen%20Fixed%20Income_0.jpeg?itok=JxvFjdWS)
Weekly Fixed Income Commentary: A hawkish Fed rattles Treasury yields higher
Weekly fixed income update highlights
- Treasuries, taxable munis, CMBS, ABS, preferreds, convertibles, high yield and investment grade corporates, loans and emerging markets weakened in total return.
- MBS and ABS delivered positive excess returns.
- Municipal bonds sold off across the curve. New issue supply was $10B, with flows of -$1.4B. This week’s new issue supply is $10B ($2B taxable).
The U.S. Treasury curve flattened, and spread assets weakened as the U.S. Federal Reserve signaled another incrementally hawkish message. The first Fed rate hike, designed to cool inflation, is expected to come in March.
Watchlist
- 10-year Treasury yields rose last week, and we anticipate increases in the quarters ahead.
- Spread assets were weaker after recent strong gains.
- Municipal bonds are unlikely to remain so rich.
Investment views
Zero/negative global interest rate policy remains a key market support. While investors continue to focus on more hawkish Fed policy, overall rates are likely to remain low.
Unprecedented global fiscal stimulus should continue to boost consumption and growth.
Record supply of investment grade corporates has been followed by high levels of issuance from high yield, middle market loans and the broadly syndicated loan market. Taxable municipal supply also continues to grow.
We favor a risk-on stance, focused on credits with durable free cash flow and solid balance sheets across a wide range of sectors. Mid-quality rating segments appear particularly attractive. Essential service municipal bonds also look compelling.
Key risks
- Inflation rises in a disorderly way, negatively affecting asset values.
- Policymakers remove accommodation too rapidly, undermining the global economic expansion.
- Further complications with the Covid vaccine rollout, as well as new variants.
- Geopolitical flare-ups: China, Russia, Turkey, Iran.
High yield corporate bonds see additional outflows
U.S. Treasury yields experienced volatility, with the 10-year yield rising as much as 12 basis points (bps) before ultimately ending only 1 bp higher at 1.77%. The two-year yield rose 16 bps and closed near the highs, sending the curve to its flattest level in more than a year. Wednesday’s Fed meeting dominated attention, with Chair Powell delivering a more-hawkish-than-expected message. In economic data, the first print of fourth quarter GDP beat expectations at 6.9%, mainly driven by a buildup in inventories rather than underlying demand. Inflation data was modestly better than feared, with the Employment Cost Index rising 1.0% in the fourth quarter.
Investment grade corporates weakened, returning -0.81% and underperforming similar-duration Treasuries by -59 bps. Most of the underperformance came after the Fed’s hawkish message, and conditions were generally volatile. The primary market calendar dried up amid the uncertainty, but supply is expected to pick up this week ($15-$20B expected) and in February ($110B expected, versus five-year average of $100B) after a majority of the IG market reports fourth quarter earnings.
High yield corporates underperformed, returning -1.28% for the week and lagging similar-duration Treasuries by -106 bps. The market saw continued retail outflows of -$2.8 billion, taking the three-week total to -$7.2 billion, the biggest such stretch of outflows since September 2020. Lower-rated names clung to recent outperformance, with CCCs returning -1.20% versus BBs -1.29%, but the gap has narrowed significantly. In loans, the technical backdrop remains strong with another $2 billion inflow for the week, though prices moved around a half point lower after reaching a 15-year high last week.
Emerging markets sold off, returning -0.33% and underperforming similar-duration Treasuries by -7 bps, making it one of the better-performing spread sectors. High yield spreads actually tightened -6 bps, while investment grade widened 5 bps. Primary market activity was robust, including a $4 billion issuance from Chile, which weighed slightly on the high-grade space. Ukraine and Russia sovereigns remained pressured amid geopolitical tensions, with bonds down -1 to -4 points across the two markets. The hawkish Fed drove a rally in the dollar, which caused emerging markets currencies to depreciate around -1.0% overall, weighing on local market returns.
Municipal bond yields rise substantially
The entire municipal bond yield curve sold off last week. Short-term bonds sold off -31 basis points and long-term bonds sold off -23 basis points.
The Fed made it official last week: it plans to tighten monetary policy to cool inflation. The first rate hike is expected in March, with more to come throughout the year. Treasury yields rose on the news, with short-term yields rising more than long-term yields (the 30-year Treasury yield rose only 2 basis points). This shift suggests that investors appear confident that the Fed will be able to curtail inflation by year end.
Municipal bond yields rose substantially last week, up and down the curve. However, this was somewhat expected as municipal bonds have been rich to Treasuries. With the selloff, municipal bonds are the cheapest they have been versus Treasuries in more than 12 months. This may attract crossover buyers to support the municipal market.
Montgomery County Higher Education and Health Authority, PA issued $649 million revenue bonds for Thomas Jefferson University (rated A2/A). Underwriters struggled to get the deal completely sold. However, yields were eventually sweetened to attract institutional investors.
The high yield municipal market is demonstrating good two-way trade flow, despite sudden recent outflows. By the end of the week, high beta names were becoming highly competitive in the secondary market. New issuance remains very light and successful. We believe this environment may offer opportunities for those who know where to look.
Emerging markets was one of the better-performing spread sectors.
In focus: The Fed is ready to go hiking
At last week’s meeting, the first of 2022, the U.S. Federal Reserve all but confirmed it will begin raising interest rates at its next meeting in mid-March.
The Fed’s policy statement acknowledged for the first time that inflation is “well above” its 2% target, while describing the labor market as “strong.” For those reasons, “the economy no longer needs sustained high levels of monetary policy support.” The Fed also confirmed that its quantitative easing asset purchase program will end in early March, before the meeting.
The statement didn’t describe how and when the Fed might begin to shrink its $9 trillion balance sheet. But at his post-meeting press conference, Chair Jerome Powell signaled that reductions “will occur over time” and that the Fed will “discuss these matters in upcoming meetings.”
Continuing January’s volatility, U.S. equity markets tumbled in the immediate wake of the meeting but gained ground over the rest of the week. Meanwhile, the 10-year Treasury yield rose sharply on Wednesday afternoon on rumblings that Fed tightening would be even more aggressive, with traders now betting on five rate increases in 2022. The 10-year yield reversed course to finish the week essentially flat.
Because we expect inflation to ease this year due to higher goods supply and softer goods demand, as well as a larger workforce, we doubt the Fed will need to go further than what the markets have currently priced in.
Performance: Bloomberg L.P.
Issuance: The Bond Buyer, 28 Jan 2022.
Fund flows: Lipper.
New deals: Market Insight, MMA Research, 26 Jan 2022.
Any reference to credit ratings refers to the highest rating given by one of the following national rating agencies: S&P, Moody’s or Fitch. Credit ratings are subject to change. AAA, AA, A and BBB are investment grade ratings; BB, B, CCC, CC, C and D are below-investment grade ratings.
Representative indexes: municipal: Bloomberg Municipal Index; high yield municipal: Bloomberg High Yield Municipal Index; short duration high yield municipal: S&P Short Duration Municipal Yield Index; taxable municipal: Bloomberg Taxable Municipal Bond Index; U.S. aggregate bond: Bloomberg U.S. Aggregate Bond Index; U.S. Treasury: Bloomberg U.S. Treasury Index; U.S. government related: Bloomberg U.S. Government-Related Index; U.S. corporate investment grade: Bloomberg U.S. Corporate Index; U.S. mortgage-backed securities; Bloomberg U.S. Mortgage-Backed Securities Index; U.S. commercial mortgage-backed securities: Bloomberg CMBS ERISA-Eligible Index; U.S. asset-backed securities: Bloomberg Asset-Backed Securities Index; preferred securities: ICE BofA U.S. All Capital Securities Index; high yield 2% issuer capped: Bloomberg High Yield 2% Issuer Capped Index; senior loans: Credit Suisse Leveraged Loan Index; global emerging markets: Bloomberg Emerging Market USD Aggregate Index; global aggregate: Bloomberg Global Aggregate Unhedged Index.
The views and opinions expressed are for informational and educational purposes only as of the date of production/writing and may change without notice at any time based on numerous factors, such as market or other conditions, legal and regulatory developments, additional risks and uncertainties and may not come to pass. This material may contain “forward-looking” information that is not purely historical in nature. Such information may include, among other things, projections, forecasts, estimates of market returns, and proposed or expected portfolio composition. Any changes to assumptions that may have been made in preparing this material could have a material impact on the information presented herein by way of example. Past performance is no guarantee of future results. Investing involves risk; principal loss is possible.
All information has been obtained from sources believed to be reliable, but its accuracy is not guaranteed. There is no representation or warranty as to the current accuracy, reliability or completeness of, nor liability for, decisions based on such information and it should not be relied on as such. For term definitions and index descriptions, please access the glossary on nuveen.com. Please note, it is not possible to invest directly in an index.
A word on risk
Investing involves risk; principal loss is possible. Debt or fixed income securities are subject to market risk, credit risk, interest rate risk, call risk, derivatives risk, dollar roll transaction risk and income risk. As interest rates rise, bond prices fall. Below investment grade or high yield debt securities are subject to liquidity risk and heightened credit risk. Preferred securities are subordinated to bonds and other debt instruments in a company’s capital structure and therefore are subject to greater credit risk. Foreign investments involve additional risks, including currency fluctuation, political and economic instability, lack of liquidity and differing legal and accounting standards. Asset-backed and mortgage-backed securities are subject to additional risks such as prepayment risk, liquidity risk, default risk and adverse economic developments. The value of convertible securities may decline in response to such factors as rising interest rates and fluctuations in the market price of the underlying securities. Senior loans are subject to loan settlement risk due to the lack of established settlement standards or remedies for failure to settle. These investments are subject to credit risk and potentially limited liquidity, as well as interest rate risk, currency risk, prepayment and extension risk, and inflation risk.
Investors should contact a tax advisor regarding the suitability of tax-exempt investments in their portfolio. If sold prior to maturity, municipal securities are subject to gain/losses based on the level of interest rates, market conditions and the credit quality of the issuer. Income may be subject to the alternative minimum tax (AMT) and/or state and local taxes, based on the state of residence. Income from municipal bonds held by a portfolio could be declared taxable because of unfavorable changes in tax laws, adverse interpretations by the Internal Revenue Service or state tax authorities, or noncompliant conduct of a bond issuer. It is important to review your investment objectives, risk tolerance and liquidity needs before choosing an investment style or manager.
Nuveen provides investment advisory solutions through its investment specialists.