Q4 gdp growth slows, despite strong “soft data”
- U.S. GDP growth fell back to a more modest +2.1% pace in Q4, aided by personal consumption, which grew at a strong 3.5% pace during the quarter.
- The Institute for Supply Management (ISM) survey of activity in the manufacturing sectors showed significant improvement over the last two quarters, reaching 57.7 in February, the highest level since 2014, before falling back slightly in March (57.2).
- The ISM survey of activity in the services sector of the economy remained strong over the quarter. The March reading of 55.2 is consistent with GDP growth in the 2-3% range.
Strong job market, equity gains boost confidence
- The labor market remained robust. Employers added an average of 178,000 jobs per month during Q1, and the unemployment rate fell to 4.5% in March – the lowest level since 2007.
- Consumer confidence rose to a 16-year high reading of 125.6 in March, boosted by job gains, real wage growth, and stocks at record high levels.
- Average hourly earnings rose at a 2.8% pace during the quarter. Over the last 12 months, workers’ average hourly earnings rose 2.7%.
Gradual rise in inflation measures keeps fed on track
- Inflation measures trended higher over the first quarter. Headline CPI and PCE rose faster during the quarter, with CPI rising to a 2.7% year-over-year pace in March. Core measures, despite having risen over the last 12-18 months, remain well contained. Core CPI rose 2.2% year-over-year in March.
- The Fed raised its policy rate by 25 basis points (0.25%) at the March Federal Open Market Committee (FOMC) meeting, to a target range of 0.75% to 1.00%.
- The Fed’s dot plot forecast released at the March FOMC meeting showed participants expect two additional hikes over 2017. Minutes of the meeting show participants also discussed reducing the size of the Fed’s balance sheet, perhaps as soon as later this year.
Trump rally challenged by healthcare reform failure
- Stocks continued their rally for most of the first quarter, with the S&P 500 setting new highs on continued optimism over the Trump business-friendly agenda.
- The administration’s very public defeat over healthcare reform damaged confidence in President Trump’s ability to work with Congress to implement his broader agenda.
- Despite the setback on healthcare reform, we continue to expect the administration to successfully advance meaningful fiscal stimulus over the next 6-12 months.
Treasuries, credit spreads little changed on quarter
- The Federal Reserve took advantage of positive market sentiment during the quarter, using coordinated messaging from Fed officials to prepare markets for a rate hike at its March FOMC meeting. Markets took the hike – and guidance for two additional hikes in 2017 – in stride.
- U.S. Treasury yields were little changed during the quarter, except at the very front end of the curve (one-month to one-year maturities), which adjusted in anticipation of the Fed’s well-telegraphed March hike.
- Investment grade corporate spreads tightened modestly during the quarter, outperforming similar-duration Treasuries (+38 bps). Overall, lower quality issuers outperformed higher quality names. Over the last 12 months, investment grade corporates outperformed Treasuries by +502 bps, with Energy and Financial names posting the strongest performance.
- Agency MBS slightly lagged U.S. Treasuries during the quarter as investors struggled to absorb impact of the significant rate move in 4Q16 on expectations for prepayment speeds and net supply. For the trailing 12 months, however, MBS managed to outperform Treasuries by 10 bps.
- ABS returns were positive during the quarter, with the sector outperforming similar duration U.S. Treasuries by +22bps. Wide front-end swap spreads helped make ABS attractive relative to corporates. Over the last 12 months, ABS outperformed Treasuries by +101 bps.
- CMBS spreads were largely unchanged during the quarter. For the full year, CMBS benefitted from strong underlying collateral performance and robust investor demand. Over the last 12 months, the sector outperformed U.S. Treasuries by +182 bps.
Credit benefits from “Trump rally”
- Corporate bonds rallied modestly during the first quarter as optimism over tax cuts and the prospect for faster growth – the “Trump rally” – remained in place for most of the quarter.
- The administration’s public defeat on healthcare reform late in the quarter spooked investors as some questioned Trump’s ability to work with Republicans to pass his broader agenda.
- Lower quality (BBB-rated) issuers generally outperformed higher quality (AA- and A-rated) names during the quarter. Spreads on financials – in particular U.S. money center banks – benefitted from strong earnings and robust investor demand.
- The Bloomberg Barclays index inclusion rules were modified to increase the minimum issue size to $300 million from $250 million for the Treasury, Corporate and Government-Related indices, effective on April 1st. Spreads on smaller “non-index” corporate and municipal bond issues widened modestly in anticipation of lower trading volumes going forward.
Record pace of corporate issuance continues in Q1
- Investment grade new issuance totaled $381 billion over the first quarter 2017, about 5.4% ahead of the same period in 2016, according to SIFMA.
- High yield new issuance swelled to $88 billion in Q1, a +144% increase from the same period last year, when the sector was gripped by downgrades in the Energy and Metals/Mining sectors.
- Within investment grade, Financials issuance represented 50% of total issuance in Q1, up from 46% in 1Q16.
- We have seen renewed interest in floating rate issuance: 20% of all new issuance in Q1 was floating rate vs. only 8% for the same period last year.
Agency MBS hurt by higher net supply, home prices continue steady rise
- Agency MBS performance lagged similar-duration U.S. Treasuries during the quarter as increased net supply in December and January weighed on valuations. In response to higher rates and mortgage extension, banks had reduced appetite to hold their newly-originated mortgages, leading to higher net supply of MBS on the market.
- The S&P CoreLogic Case-Shiller 20-City Home Price Index posted a +5.7% year-over-year increase through January, marking the 30th consecutive month of consistent ~5% year-over-year home price appreciation.
- Following a large spike in the fourth quarter, the Freddie Mac Weekly Survey Rate of 30-year mortgage rates averaged 4.17% during Q1, hovering around the highest levels in nearly three years. As the result of higher mortgage rates, the Mortgage Bankers’ Association’s Refinancing Index remained near a 15-year low during the quarter.
CMBS issuance muted, ABS volumes rise
- CMBS new issue supply fell 35% in the first quarter vs. the same period last year. CMBS volumes have been most impacted by a 20-40% decline in real estate transactions nationally since the November election as investors await clarity on potential tax policy changes.
- ABS new supply rose 45% during the quarter vs. a year ago, largely the result of significant supply of credit card ABS. Consumer revolving credit has continued to grow modestly, and a number of issuers have significant bond maturities this year following heavy issuance of three-year bonds in 2014.
The information contained herein reflects the views of Galliard Capital Management, Inc. and sources believed to be reliable by Galliard as of the date of publication. No representation or warranty is made concerning the accuracy of any data and there is no guarantee that any projection, opinion, or forecast herein will be realized. The views expressed may change at any time subsequent to the date of publication. This publication is for information purposes only; it is not investment advice or a recommendation for a particular security strategy or investment product. FOR INSTITUTIONAL INVESTOR USE ONLY. © Galliard Capital Management, Inc.