The consistent bond volatility we saw take place in 2022 was unprecedented for a 12-month period. The recent week(s) has made last year look sanguine. As shown by the ICE BofA MOVE Index, recent bond volatility easily surpassed the peak of March 2020, and the highest we have seen since 2008.
Source: Bloomberg, ICE BofA MOVE Index
Much of that volatility has been largely driven by the short-end of the curve, with the 2-yr UST seeing, now, 9 straight days of at least 20-bp swings in either direction.
Source: Bloomberg, US Generic Government 2yr
This, of course, has led to wild swings, often on the back of low liquidity, of the 2/10 UST yield curve. As the market attempts to come to terms with the likelihood of a “hard-landing” and potential stagflationary environment, the yield curve has steepened, though still deeply inverted, from -110 bps on March 8 to a (at time of writing) -57 bps.
Source: Bloomberg, US 2yr and 10yr Note Spread
With the changing market dynamics, pricing for upcoming FOMC rate hikes has whipsawed all over with forward pricing showing a peak north of nearly 5.75% after Chairman Powell’s congressional testimony on March 8, with aggressive rate cuts being priced in by close of March 17. We still feel that, barring some major news over the next 24 hours (which is always a possibility), the market got a little ahead of itself with the idea the Fed would have to cut rates, and we expect at least a 25-bp hike tomorrow, the 22nd. While we do feel the recent market instability will cause The Committee to add some carefully crafted language to statement, inflation remains the number one battle, and there is still work to do on that front before, they feel, things really break.
Source: Bloomberg WIRP, Fed Funds Futures
The Credit Suisse AT1 Bond wipeout is in no way a representation of the broader IG corporate market, but it is a reminder as to how quickly corporate credit can change. Municipal event risk and municipal defaults are not only much more seldom, but recovery has historically been much stronger vs corporate counterparts. Full credit write-up to follow from our team, but a quick look at some of the larger headline defaults in the municipal market over the years, courtesy of Moody’s:
Source: Moody's US Public Finance, Municipal Bond Defaults and Recoveries, 1970-2021
Compared to most other fixed income markets across the globe, the municipal market is one of the few to actually shrink in size. Municipal issuers have done a great job of paying down debt, being more selective in new issuance, and building cash balances for slowdown.
Source: SIFMA, Federal Reserve
All that being said, we do continue to feel comfortable in adding strong A/BBB-rated names, upon these periods of spread widening, that are well-positioned to weather a potential economic slowdown.
Source: Bloomberg; US Revenue A Muni BVAL TEY assumes 37% Fed Rate, 3.8% Net investment income tax; USD US Composite A BVAL Yield Curve; US Treasuries Monitor; March 20, 2023 close
Wishing you a great week. Please do not hesitate to contact our team should you have any questions.
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