December 23, 2024

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Munis quiet amid UST sell-off

10 min read

Municipals were steady to weaker in spots Monday, while U.S. Treasuries sold off amid Federal Reserve Board Chairman Jerome Powell warning about widespread inflation and talks over hiking interest rates quicker than the Fed initially planned last week.

As a result, muni-to-UST ratios fell. The five-year was at 72%, 85% in 10-years and 92% in 30, according to Refinitiv MMD’s 3 p.m. read. ICE Data Services had the five at 72%, the 10 at 88% and the 30 at 95% at 4 p.m.

Given macroeconomic events, still-rising inflation, and now a return of COVID-19 in many areas of the world, the natural inclination is for credit spreads to widen. While this is happening in corporate bonds, municipal bonds aren’t seeing the same credit stress, said Eric Kazatsky, head of municipal strategy at Bloomberg Intelligence.

Muni performance has been strong as of late and spreads have actually corrected after a month of gradual widening, according to Kazatsky. The Bloomberg Municipal High-Yield Index’s option-adjusted spreads fell 6 basis points to their lowest level since late February.

When looking at the Van Eck High-Yield Muni ETF’s NAV, he said, high-yield municipal valuation attitude has flipped, with buyers now willing to pay a premium after the ETF was trading at a discount to NAV for all of 2022. Over the past week, fund flows have also been positive.

“For munis, the hope is that positive energy is a self-fulfilling prophecy that will, in turn, lead to a reversal of fund-flow direction,” he said. “In many ways, the technical set-up and market tone feel similar to 2013, when both flows and returns were persistently negative.”

Taxable muni spreads have widened slightly in recent weeks, but not nearly as much as during the COVID-19 crisis, indicating that taxable investors are not panicking and municipal credit is still in good condition, especially for lower-rated names, according to Barclays PLC.

Barclays strategists Mikhail Foux, Clare Pickering and Mayur Patel said when low-rated taxable municipals are compared to corporates, however, a different picture emerges. Triple-B corporates have been subjected to far more pressure than municipals, and the yield differential between corporates and munis has reached new highs.

They said triple-B corporates have rebounded marginally, narrowing the gap slightly, although it remains large. Overall, Barclays strategists said this appears to be a message that investors should be cautious for the time being, particularly with lower-rated taxable credits, until corporates show indications of stabilization.

Additionally, the fourth quarter of 2021 followed the same pattern as the preceding quarters. Direct retail investors reduced their exposure, but banks and mutual funds stepped in to fill the void. Other investor groups’ municipal holdings have remained mostly unchanged.

Direct retail reduced its muni exposure by $125 billion over the course of the year, while mutual funds raised their holdings by almost $120 billion (with about $20 billion migrating into ETFs). Meanwhile, banks added close to $35 billion, and dealers gained $5 billion. The market’s overall size has grown by $60 billion to $4.05 trillion in 2021, said Barclays strategists.

Secondary trading
Columbus, Ohio, 4s of 2023 at 1.22%. District of Columbia 5s of 2033 at 1.22%. Maryland 5s of 2023 at 1.25-1.28%.

Cambridge, Massachusetts, 5s of 2025 at 1.53%. Maryland 5s of 2025 at 1.57%. Indiana Finance Authority 5s of 2025 at 1.77%.

Montgomery County, Maryland, 5s of 2026 at 1.69-1.70%. Florida 5s of 2027 at 1.78-1.79%. Austin, Texas, 5s of 2027 at 1.74-1.78%.

Baltimore County, Maryland, 5s of 2033 at 2.09%.

California 5s of 9/2041 at 2.54% versus 2.58-2.62% on Wednesday and 2.57-2.58% on March 14. California 5s of 10/2041 at 2.50-2.53%. LA DPW 5s of 2051 at 2.63% versus 2.76% Wednesday and 2.64-2.71% on March 14.

AAA scales
Refinitiv MMD’s scale were cut zero to two basis points at the 3 p.m. read: the one-year at 1.18% (+2) and 1.41% in two years (+2). The five-year at 1.67% (+2), the 10-year at 1.95% (+2) and the 30-year at 2.33% (unch).

The ICE municipal yield curve was cut one to three basis points: 1.15% (+3) in 2023 and 1.46% (+3) in 2024. The five-year at 1.68% (+3), the 10-year was at 2.01% (+3) and the 30-year yield was at 2.40% (+1) in a 4 p.m. read.

The IHS Markit municipal curve was cut a basis point: 1.17% (+1) in 2023 and 1.40% (+1) in 2024. The five-year at 1.67% (+1), the 10-year at 1.94% (+1) and the 30-year at 2.34% (+1) at a 4 p.m. read.

Bloomberg BVAL saw one to three basis point cuts: 1.15% (+2) in 2023 and 1.40% (+2) in 2024. The five-year at 1.68% (+3), the 10-year at 1.96% (+2) and the 30-year at 2.33% (-2) at a 4 p.m. read.

Treasuries rose while equities fell.

The two-year UST was yielding 2.130%, the five-year was yielding 2.332%, the seven-year 2.355%, the 10-year yielding 2.310%, and the 30-year Treasury was yielding 2.534% at 4 p.m. The Dow Jones Industrial Average lost 201.94 points or 0.58%, the S&P down 1.94% while the Nasdaq lost 0.31% at the close.

Taming inflation
It may take three years for inflation to decline to the Federal Reserve’s 2% target, but Fed Chair Jerome Powell is confident a soft-landing is possible and is committed to price stability even if it means raising rates faster than planned.

“There is an obvious need to move expeditiously to return the stance of monetary policy to a more neutral level, and then to move to more restrictive levels if that is what is required to restore price stability,” he told the National Association for Business Economics, according to prepared text released by the Fed. “We are committed to restoring price stability while preserving a strong labor market.”

“Forecasters widely underestimated the severity and persistence of supply-side frictions, which, when combined with strong demand, especially for durable goods, produced surprisingly high inflation,” Powell said. “The pandemic and the associated shutdown and reopening of the economy caused a serious upheaval in many parts of the economy, snarling supply chains, constraining labor supply, and creating a major boom in demand for goods and a bust in services demand.”

And the expectations that inflation would decline in the last half of 2021 never came to fruition, he said. “Part of the reason may be that, contrary to expectations, COVID has not gone away with the arrival of vaccines,” Powell noted. “In fact, we are now headed once again into more COVID-related supply disruptions from China. It continues to seem likely that hoped-for supply-side healing will come over time as the world ultimately settles into some new normal, but the timing and scope of that relief are highly uncertain. In the meantime, as we set policy, we will be looking to actual progress on these issues and not assuming significant near-term supply-side relief.”

Powell said the Fed’s moves “will help bring inflation down near 2% over the next 3 years” and that a soft landing is possible.

“Soft, or at least soft-ish, landings have been relatively common in U.S. monetary history,” he said. The Fed engineered soft landings in 1965, 1984, and 1994, Powell said. “In other cases, recessions chronologically followed the conclusion of a tightening cycle, but the recessions were not apparently due to excessive tightening of monetary policy.”

The latest recession was caused by the pandemic, not Fed tightening, he added.

But the Russian invasion of Ukraine adds a wrinkle, Powell said. “The added near-term upward pressure from the invasion of Ukraine on inflation from energy, food, and other commodities comes at a time of already too high inflation. In normal times, when employment and inflation are close to our objectives, monetary policy would look through a brief burst of inflation associated with commodity price shocks. However, the risk is rising that an extended period of high inflation could push longer-term expectations uncomfortably higher, which underscores the need for the Committee to move expeditiously as I have described.”

Separately, Federal Reserve Bank of Atlanta President Raphael Bostic revealed he expects six rate hikes this year and two next year.

“Obviously, the baseline for inflation has moved up significantly,” he told the National Association for Business Economics. “My original outlook was that inflation would likely begin decelerating this spring. That almost certainly won’t happen now. Let me say clearly that getting the high rates of inflation under control is the top concern for me for 2022.”

Uncertainty is elevated, Bostic noted, which has “tempered my confidence that an extremely aggressive rate path is appropriate today. Events are shifting rapidly, and we could see marked changes along key dimensions, such as aggregate demand, that could warrant quickly adjusting the trajectory of policy.”

Both Fed officials left open the possibility of faster or slower rate hikes, depending on the economy.

But, Matt Dines, chief investment officer and co-founder of Build Asset Management, said the Fed last week may have hinted at a “Fed put” — “an acknowledgment that there’s an event on the horizon that will require an easing of financial cycles.”

The Fed’s success in taming inflation, he said, “will depend on whether policy makers have correctly identified the root cause. Over the quarters ahead, markets and the economy are about to find out whether the surging price levels in the economy are in fact monetary in nature (which the Fed can actually address through tightening financial conditions) or something else, such as supply chain disruptions, global trade-related issues, or resource and input constraints.”

The Summary of Economic Projections suggests a median fed funds rate of 2.75% in 2024 but a long-term 2.375% level. Dines said, this is “the first appearance of an inversion in the FOMC’s guidance curve for the fed funds rate since December 2018.”

The implication, he said, is the Fed “will over-hike and then eventually cut.” Although, Dines noted, it’s unclear what will cause the Fed to cut rates or when after 2024 it will happens. The market agrees with this scenario, he said, but not the timing. The markets expect a rate cut in 2023 or 2024.

“What this suggests is that the money managers in the global credit markets see this hike cycle peaking in short-term through their foggy crystal ball, just as it’s already getting started,” Dines said. “The Fed now implicitly acknowledges this, but says these events are further out.”

The market saw the dot plot “as evidence they’ll get what they want: the next time turmoil hits financial markets and the broader economy, the Fed put will be there.”

Primary to come:
New York City (Aa2/AA/AA-/AA+) is set to price Wednesday $890.910 million of tax-exempt general obligation bonds, consisting of $640.905 million, Fiscal 2022 Series B, Subseries B-1, serials 2023-2036 and $250.005 million, Fiscal 2022 Series C, serials 2022-2033. Citigroup Global Markets.

The Illinois Finance Authority (Aa3/AA-/) is set to price Tuesday $594.555 million of Northshore Edward Elmhurst Health revenue bonds, Series 2022A. J.P. Morgan Securities.

Hoag Memorial Hospital Presbyterian, California, (/AA/AA/) is set to price Wednesday $538.700 million of corporate CUSIP taxable revenue bonds, Series 2022. J.P. Morgan Securities.

Brevard County Health Facilities Authority, Florida, (A2/A/) is set to price Tuesday $445.250 million of hospital revenue bonds, Series 2022A and forward delivery hospital revenue bonds, Series 2023A. J.P. Morgan Securities.

New York City Housing Development Corp. is set to price Thursday $400.395 million of taxable sustainable development capital fund grant program revenue bonds, Series 2022A. J.P. Morgan Securities.

New York State Housing Finance Agency (Aa2///) is set to price Tuesday $235.790 million of affordable housing revenue bonds, consisting of $123.410 million of climate bond certified/sustainability bonds, 2022 Series A-2, serial 2060; $94.535 million of sustainability bonds, 2022 Series B-2, serial 2060 and $17.845 million of federally taxable climate bond certified/sustainability bonds, 2022 Series C, serial 2027. Ramirez & Co.

New York State Housing Finance Agency (Aa2///) is also set to price Wednesday $192.855 million of affordable housing revenue bonds, consisting of $85.065 million of climate bond certified/sustainability bonds, 2022 Series A-1, serials 2024-2034, terms 2037, 2040,2042, 2045, 2047, 2052, 2055 and 2060 and $107.790 million of social bonds, 2022 Series B-1, serials 2022-2034, terms 2037, 2040, 2042, 2045 and 2052. Jefferies.

Lamar Consolidated Independent School District, Texas, (Aaa/AAA//) is set to price Thursday $393.035 million of unlimited tax schoolhouse bonds, Series 2022, serials 2024-2062, insured by Permanent School Fund Guarantee Program. RBC Capital Markets.

The Chicago Transit Authority (/A+//AA-/) is set to price Wednesday $349.925 million of second lien sales tax receipts revenue bonds, Series 2022A, serials 2041-2042, terms 2047, 2052 and 2057. Cabrera Capital Markets.

School District 27J, Colorado, (Aa2/AA//) is set to price Tuesday $264.505 million of general obligation bonds, Series 2022, serials 2022-2041, term 2046, insured by Colorado State Intercept Program. RBC Capital Markets.

The Industrial Development Authority of Phoenix, Arizona, is set to price Tuesday $198.355 million of economic development revenue bonds, Tax-Exempt Series 2022A and Taxable Series 2022B, consisting of $172.280 million of Series 1 and $26.075 million of Series 2. D.A. Davidson & Co.

The Tennessee Housing Development Agency (Aa1/AA+//) is set to price Tuesday $175 million of non-alternative minimum tax social residential finance program bonds, Issue 2022-1, serials 2023-2034, terms 2037, 2042, 2045 and 2052. Raymond James & Associates.

California Public Finance Authority (/AA/AA/) is set to price Wednesday $168.540 million of fixed period revenue bonds, Series 2022A. J.P. Morgan Securities.

North Carolina Housing Finance Agency (Aa1/AA+//) is set to price Wednesday $150 million of non-alternative minimum tax social home ownership revenue bonds, Series 48, serials 2023-2034, terms 2037, 2042, 2045 and 2052. RBC Capital Markets.

Arlington Higher Education Finance Corp. (/AAA//) is set to price Tuesday $135.005 million of education revenue bonds, Series 2022, serials 2024-2057. PNC Capital Markets.

Competitive:
Palo Alto Unified School District, California, (Aaa/AAA/) is set to sell $38 million of general obligation bonds (Election of 2008), Series 2022, at noon eastern Tuesday.

Palo Alto Unified School District, California, (Aaa/AAA/) is set to sell $240 million of general obligation bonds (Election of 2018), Series 2022, at 1 p.m. Tuesday.

Beverly Hills Unified School District, California, (Aa1/AA+/) is set to sell $110 million of taxable Election of 2018 general obligation bonds, Taxable Series B-1, at noon eastern Wednesday.

Beverly Hills Unified School District, California, (Aa1/AA+/) is set to sell $115 million of Election of 2018 general obligation bonds, Taxable Series B, at 1 p.m. Wednesday.

Anne Arundel County, Maryland, (Aaa/AAA/-) is set to sell $67.625 million of general obligation bonds, consisting of $44.780 million of consolidated general improvement series, 2022 Refunding Series and $22.845 million of consolidated water and sewer series, 2022 Refunding Series, at 10:45 a.m. Wednesday.

Anne Arundel County, Maryland, (Aaa/AAA/-) is set to sell $194.690 million of general obligation bonds, consisting of $137.145 million of consolidated general improvement series, 2022 Series and $57.545 million of consolidated water and sewer series, 2022 Series, at 10:15 a.m. Wednesday.

The Virginia Transportation Board (Aa1/AA+/AA+/) is set to sell $115.320 million of transportation revenue bonds, Series 2022 at 10:30 a.m. Wednesday.

Albuquerque, New Mexico, is set to sell $104.315 million of general obligation bonds, consisting of: $76.395 million of general purpose bonds, Series 2022A; $4.305 million of storm sewer bonds, Series 2022B and $23.615 million of refunding bonds, Series 2022D, at 11 a.m. eastern Thursday.

The Regents of the University of Michigan (Aaa/AAA//) is on the day-to-day calendar with $582.740 million of taxable general revenue bonds, Series 2022C. Goldman Sachs & Co.

The Arizona Sports and Tourism Authority (/AA//) is on the day-to-day calendar with $144.835 million of senior revenue and revenue refunding bonds, Series 2022, serials 2024-2036, insured by Build America Mutual Assurance Co. RBC Capital Markets.