(The following commentary is a summary of discussions among members of the Breckinridge Capital Advisors Investment Committee as they reviewed monthly activity in the markets and investment returns. The members of the Investment Committee under the leadership of Chief Investment Officer Ognjen Sosa, CAIA, FRM, are Co-Head of Portfolio Management, Matthew Buscone; Senior Portfolio Manager Sara Chanda; Co-Head of Research, Nicholas Elfner; Co-Head of Portfolio Management, Jeffrey Glenn, CFA; Head of Municipal Trading, Benjamin Pease; and Co-Head of Research, Adam Stern, JD.)

Market Review

July offered a welcome respite from the negative returns experienced thus far this year as both equity and fixed income markets rebounded sharply despite negative gross domestic product (GDP) reading for the second consecutive quarter, a 75-basis points (bps) increase in the federal funds rate, continued high inflation measures, and declining consumer confidence.

Responding to weak economic data, Treasuries rallied (See Figure 1). Treasury yields for maturities in the 2-, 5-, 10-, and 30-year ranges were lower by 7, 36, 36, and 17bps, respectively.

As Treasury rates declined, the yield curve inverted. At July 31, the 2-year Treasury yield was 2.89 and the 10-year yield was 2.65 percent.

During July, the S&P 500 Index added 9.1 percent. The Bloomberg U.S. Treasury Bond Index was up 1.59 percent. The Bloomberg U.S. Aggregate Bond Index gained 2.44 percent. Bonds within the Aggregate index with longer maturities and lower credit quality ratings earned higher returns.

At its July meeting, the Federal Open Market Committee hiked the fed funds target rate range to 2.25 percent to 2.50 percent, an increase of 75bps. Still, some commentators considered Chair Powell’s media comments to be more dovish compared with the tone following June’s 75bps increase. The Fed’s own dot plot suggests a median forecast of 3.50 percent for the funds rate by the end of 2022, which would assume another 100bps in hikes, including a projected 50bps increase at the September meeting.

The month ended with a run of downbeat economic data. A 0.9 percent decline in GDP in Q2 followed the 1.6 percent decline in Q1, according to the Bureau of Economic Analysis (BEA). A 14 percent decline in residential investment, according to the U.S. CoreLogic S&P Case-Shiller Index for June included drops in new and pending home. According to the National Association of Realtors, pending home sales declined 8.6 percent from May, as higher mortgage rates and housing prices deterred potential buyers.

The Commerce Department reported weakness in business investment, with an unexpected decline in equipment investment beyond auto and truck shortages. University of Michigan consumer sentiment indicators remain weak, especially on expectations.

While two consecutive quarters of negative GDP changes may technically define a recession, many observers hold that the National Bureau of Economic Research (NBER) is unlikely to call it so given the low level of unemployment, positive payroll growth, and distortions declining inventories and net exports.

The Q2 Employment Cost Index suggested that wage growth continued to run above 5 percent, in contrast to softening in the average hourly earnings figures.

Weaker economic readings also were offset by consumption growth, which slowed to 1.0 percent in Q2 from 1.8 percent in Q1, the BEA reported. Personal income and spending grew 0.6 percent and 1.1 percent in June, respectively, although real spending adjusted for inflation was just 0.1 percent. For June, the Personal Consumption Expenditures (PCE) and Core PCE deflator were in line with consensus at 6.8 percent and 4.8 percent growth year-over-year, respectively

Municipal Market Review

Municipal yields decreased (See Figure 2). Yields fell by 35bps in the 2-year spot and dropped 42, 51, and 29bps, respectively, at 5-, 10-, and 30-year maturities. The curve flattened by 16bps between 2- and 10-year maturities (the 2s/10s curve), while the 2s/30s curve steepened modestly by 6bps.

Municipal bonds outperformed Treasuries and Municipal/Treasury ratios moved lower across the curve, suggesting less attractive relative value for tax-exempt municipals. (See Figure 3).

Municipal bond supply repeated a familiar historical pattern by falling in July. July's total issuance was down 32 percent year-over-year (y/y), according to The Bond Buyer. Issuance of taxable municipal bonds and refunding led the trend lower.

July tax-exempt bond issuance was 20 percent lower than the same month in 2021, while monthly taxable municipal bond issuance was more than 70 percent lower y/y.

Refundings are almost 77 percent lower than last year, as higher yields have eliminated the potential for interest rate savings.

Lower new-issue supply and a decrease in mutual fund outflows helped support the rally in July.

Asset outflows continued from municipal bond funds, but significantly slowed, with two weeks of inflows helping moderate the year-to-date trend. Per Lipper, outflows were $569 million.

The Bloomberg Managed Money Short/Intermediate (1-10) Index surged 2.29 percent and the Bloomberg 1-10 Year Blend Index added 1.92 percent. Longer maturity bonds outperformed shorter maturity issues. Bonds with lower credit quality ratings tended to perform better than higher rated bonds.

With fund flows potentially turning positive and August typically being a net negative supply month, we continue to expect the technical environment to be supportive as the summer closes.

Corporate Market Review

IG corporate bond spreads tightened by 12bps, per Bloomberg data, ending July at 144bps. The Bloomberg U.S. Corporate Investment Grade (IG) Index gained 3.24 percent on a total return basis and delivered an excess return of 1.09 percent compared with duration-matched Treasuries.

The best-performing sectors were railroads, food & beverage, aerospace/defense, restaurants and health insurance. The worst-performing were foreign local government, airlines, supranationals, metals and mining and real estate investment trusts. Lower quality tended to outperform higher quality and longer maturities were favored over shorter maturities.

Index-eligible IG bond issuance in July, per Bloomberg, was $98 billion, $2 billion higher than June’s issuance. Net issuance, after redemptions, was $33 billion. According to Emerging Portfolio Fund Research, IG bond funds reported approximately $2 billion of outflows.

Securitized Market Review

July for mortgage-backed securities was the best month on record in terms of excess returns over duration matched Treasuries, with the Bloomberg MBS Passthroughs Index earning an excess return of 129bps. The notable performance helped to recapture a sizable portion of the cumulative year-to-date underperformance, which stood at 0.48 percent by month-end.

Across the sector, bonds with coupons ranging from 2 percent to 3.5 percent delivered excess returns of greater than 100bps.

Within CMBS, agency-CMBS underperformed while non-agency had a strong month producing 20bps of excess returns.

Within the ABS market, securities backed by credit card debt earned a total return of 82bps and a negative excess return of 5bps, while bonds backed by auto loans earned a total return of 30bps and a negative excess return of 12bps.

#302782 (8/8/2022)

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