Fixed Income

Fixed Income Commentary – March 2023

Bumpy Ride

February was a stark contrast to January: bond yields rose across the entire yield curve.  What caused this shift?  Strong economic data and higher than expected inflation reports, both of which could lead to a higher terminal fed funds rate and a “higher for longer” stance by the Fed.  It goes without saying that any hopes of a rate cut in 2023, as some had been forecasting, is off the table.  As a result of the move to higher yields, the broad market total return was negative: the Bloomberg Intermediate U.S. Aggregate Bond Index return was -2.07% while the Bloomberg Municipal Index return was -2.26%.

First, a review of the strong economic data:

• The non-farm payroll report for January came in at 517K and the prior two months were revised up by 71K.  While the report was the subject of some confusion due to the annual revisions to the benchmark data, other details corroborated the strength such as the dip in the unemployment rate to 3.4% (these are based off two different surveys), the jump in the average workweek to 34.7 hours, and continued low unemployment claims.

• Retail sales surged higher in January: the month-over-month growth was 3.0%.  A derivation referred to as the “control group” (representing those sales used to compile the Personal Consumption Expenditures report) rose 1.7% and showed broad-based gains.  After declines in three of the prior four months, this report demonstrated the resilience of the consumer, perhaps owing to the strong labor market.

• ISM Services for January came in at 55.2, up significantly from the prior month’s revised 49.2.  Recall that any figure above 50 in this diffusion index indicates expansion, and the post-pandemic increase in services remains a nascent trend.  The new orders component of the report spiked to 60.4 from 45.2 in the prior month, and employment rose to 50.

• New home sales took a surprising bounce higher, up 7.2% in January after an upward revision to the December data.  This was very likely a result of the dip in mortgage rates that came about late in the year and early January.

• Consumer spending in January was up 1.1% following declines the prior two months and yet again stoking the resilience theme.  This also brings to mind the “revenge spending” theory of a post-pandemic consumer, particularly since travel-related and services spending were distinctly robust.

These reports provide a green light for the Fed to continue raising rates and to keep them in restrictive territory for a longer period in order to ensure the inflation battle is won.  If successful in reining in inflation, the Fed’s credibility would also be restored.

As for inflation, the popular narrative at the start of the year was that it had peaked and would return to the Fed’s 2% target as early as next year.  After the January inflation report, however, many are now rethinking this trajectory.  There are signs that wage inflation is moderating and supply chain bottlenecks are dissipating, but the recent reports make clear that it is too soon to declare victory.

Another less favorable development was the core PCE report — the Fed’s preferred inflation measure — which jumped 0.6% month-over-month and 4.7% year-over-year, both higher than expected and further evidence that some elements of inflation are proving stubborn.

Housing-related inflation remains problematic since shortages of housing persist in many areas of the country.  The remedy for this sort of problem — more supply — should allow for more tame annual rent increases to develop as market imbalances are cured.  Indeed, the high rent inflation observed over the last year or so does appear to be abating, and Wells Fargo reports that the count of multifamily units currently under construction is at its highest level since 1974.  If some of this new inventory is located in those markets most acutely out of balance, rent inflation should come down in due course, but it will not happen overnight.

We are much more constructive on the bond market now that yields have repriced to reflect the likelihood of more rate hikes and a longer period of holding rates steady before ultimately beginning to cut.  Translation: investors are being paid much better for taking risk and yields appear fair.  Three additional 25bp rate hikes in March, May, and June are now priced into market yields.  This would bring the terminal rate to 5.25%-5.50%.

In the municipal market, yield ratios (municipal yields as a percentage of Treasury yields) have improved a bit but remain on the rich side, perhaps reflecting the light supply of new issues year-to-date.  Meanwhile, yield spreads in the corporate sector have also widened which makes this sector more attractive from a risk-reward perspective.

As we look ahead, it seems clear that Fed tightening is closer to reaching an endpoint than not, so financial markets could soon begin to focus on other factors rather than the next Fed meeting.  The cumulative rate hikes are designed to slow the economy sufficiently to allow inflation pressure to come down and that process could result in unforeseen stress on certain parts of the economy.  If that stress proves too disruptive or disorderly, financial market volatility may turn higher, but the underlying strength noted above provides some comfort about the resilience of the U.S. economy.

Important Disclosures

Maple Capital Management, Inc. (MCM) is an independent SEC Registered Investment Advisor with offices in Montpelier, Vermont and Atlanta, Georgia.

This commentary reflects the views of MCM and should not be considered to be investment or financial advice. MCM does not warranty these views and will not update this communication after the date of publication.  Any mention of specific securities is done for illustrative purposes and the securities mentioned may or may not be held in client accounts.  No assumption or assurance should be taken that securities mentioned will be safe or profitable investments.  Past performance is not indicative of future results

For further information, please contact Steven Killoran at 1-802-229-2838 or at [email protected].  For further information about Maple Capital, including a copy of our informational brochure, please visit our website at

Index Definitions

The Bloomberg US Aggregate Bond Index is a broad-based flagship benchmark that measures the investment grade, US  dollar-denominated, fixed-rate taxable bond market. The index includes Treasuries, government-related and corporate securities, MBS (agency fixed-rate pass-throughs), ABS and CMBS (agency and non-agency).

The Bloomberg Intermediate US Aggregate Bond Index is a broad-based flagship benchmark that measures the investment  grade, US dollar-denominated, fixed-rate taxable bond market with less than 10 years to maturity. The securitized sector is wholly inluded. The index includes Treasuries, government-related and corporate securities, MBS, ABS and CMBS..

The Bloomberg US Treasury Index measures US dollar-denominated, fixed-rate, nominal debt issued by the US Treasury.  Treasury bills are excluded by the maturity constraint, but are part of a separate Short Treasury Index. STRIPS are excluded from the index because their inclusion would result in double-counting.

The Bloomberg US Credit Index measures the investment grade, US dollar-denominated, fixed-rate, taxable corporate and government related bond markets. It is composed of the US Corporate Index and a non-corporate component that includes foreign agencies, sovereigns, supranationals and local authorities.

The Bloomberg US Mortgage Backed Securities (MBS) Index tracks fixed-rate agency mortgage backed pass-through securities guaranteed by Ginnie Mae (GNMA), Fannie Mae (FNMA), and Freddie Mac (FHLMC). The index is constructed by grouping individual TBA-deliverable MBS pools into aggregates or generics based on program, coupon and vintage.

The Bloomberg US Corporate High Yield Bond Index measures the USD-denominated, high yield, fixed-rate corporate bond market. Securities are classified as high yield if the middle rating of Moody’s, Fitch and S&P is Ba1/BB+/BB+ or below. Bonds from issuers with an emerging markets country of risk, based on Bloomberg EM country definition, are excluded.

The Bloomberg U.S. Municipal Index covers the USD-denominated long-term tax exempt bond market. The index has four main sectors: state and local general obligation bonds, revenue bonds, insured bonds and prerefunded bonds.