Did I mention the original name of the game was Snakes and Ladders. Now that sounds a bit scarier.
Brexit Starts a Muni Rally
The quarter was dominated by the May jobs report and Brexit. The quarter began with munis firm in price but priced fairly richly, in our opinion, compared to Treasury bonds. A punk May payroll number of 38,000 started a rally in Treasury bonds and munis followed suit.
The July reinvestment which consists of interest payments and matured bonds in munis has traditionally created strong demand. The Brexit vote on June 23 caused Treasury 10-year bonds to spike to a 1.40% yield at one point in overnight trading. That morning the first trades in munis were 12-18 points lower in yield. My experience, after having traded in munis on summer Fridays, has been that when the market gaps open, volume tends to come to a grinding halt as participants try to digest the new lower levels. That was not the case this time. With negative rates in sovereign debt worldwide and munis having investment grade ratings, there was a consistent bid to find value in the market all day.
Treasury bonds closing the quarter at 1.47% and the 10 year AAA muni right around that range really is unprecedented. The July reinvestment flows will determine if there is follow through to new yield lows.
Credit Was Calm . . . and Then It Wasn’t
High yield continued to rally off its lows set in February when oil bottomed and kept grinding higher as there were very few sellers in the market. New issues came into the market and refinanced higher coupons with ease. Some lower credit commodity companies opportunistically bought back their debt at discounts to par.
Investment grade credits kept pace with rallying Treasury bonds and in many cases traded at spreads that continued to tighten. The hold music for a bond dealer I call was “Summer Wind” by Sinatra – it was all so calming. Who knew the Brits and their “stiff upper lip” pride would cause an EU exit vote to win and the markets to be roiled.
The 1.70% yield on 10-year Treasury bonds was a technical area that we thought could cause a further move lower in yields if it was breached. This happened on June 9th. Bonds successfully re-tested that area and then rallied back to the lows.
Related: Central Banks Policies… Everyone Gets a Trophy
Then it happened. Britain voted for independence to leave the EU and go on their own. Equities sold off, gold soared, high yield bonds were hit and Treasury bonds traded to an overnight low of 1.40% on the 10-year bond. The high yield sell-off was limited to certain issues. It did not seem like the start of a huge sell-off but appeared as if buyers used the opportunity to add to positions. Sure enough after a sell-off of a day, high yield rallied on June 28th.
Brexit created a several day volatility event, a chute that took away the probability of a July rate hike. As to where it goes from here, we will keep monitoring and actively managing. One thing that seems likely from the outcome of Brexit is that central banks will continue to be accommodative until more ladders appear.
Jamie Mullen is a Senior Portfolio Manager at Clark Capital Management Group, a participant in the ETF Strategist Channel.
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