November 21, 2024

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Munis quiet, larger calendar awaits investors; UST curve inversion stirs recession fears

11 min read

Municipals were mostly steady to close out the week, but the 30-year U.S. Treasury ended lower than the entire short end of the curve,increasing fears about the rising possibility of a recession, while equities ended in the black.

Triple-A municipal yield curves were relatively stable, while the two-, three-, five- and seven-year UST ended higher than the 10- and 30-year.

Muni to UST ratios were at 78% in five years, 92% in 10 years and 104% in 30, according to Refinitiv MMD’s 3 p.m. read. ICE Data Services had the five at 75%, the 10 at 93% and the 30 at 105% at 4 p.m.

BofA Global Research strategists said the combination of a strong, hawkish Fed and rate shock will only work to restrict economic activity and keep inflation from rising higher.

“So the question now becomes: how deep of an inversion is the Fed is willing to drive,” they said. “Irrespective of recession or not, yield curve inversion is good for bond investors.”

If history is any guide, BofA strategists said curve bear flattening during a Fed tightening cycle eventually leads to a strong rally in the long end of the curve, with deeper curve inversion developing, and the end of Fed tightening will soon usher in a bull flattening as investors anticipate a Fed rate cut.

They said this time is no different, except the Fed sounds as if it intends to accomplish more in a shorter amount of time.

And while prior yield inversions have been known to signal impending recessions, AXS Investments CEO Greg Bassuk cautioned investors against putting too much faith in the inversion’s capacity to anticipate a recession in this case.

First, no single data point is flawless in recession predicting and, therefore, even prior yield inversions have been colossally imprecise at foretelling the accurate arrival time of a recession.

“Today’s environment exhibits Fed policy, geopolitical tensions, and one of the worst ever health pandemics hovering over the U.S. and global economies, all of which will impact the extent to which a recession will manifest, without regard to predictions based on yield inversion,” Bassuk said.

Furthermore, no previous yield curve inversion happened when the Fed’s actions and expectations paralleled those of today’s central bank. Because of the Fed’s one-of-a-kind involvement in bond markets, the 10-year Treasury rate has been artificially decreased, they said, and so the inverted yield curve is occurring more synthetically than spontaneously. He noted that the Fed’s massive balance sheet and the world’s historically low bond rates cannot be overlooked.

Per Refinitiv MMD, the one-year tax-exempt triple-A muni yield has increased 140 basis points, the five year 150 basis points, the 10-year yield increased 114 basis points and the 30-year triple-A yield rose 103 basis points in the first quarter of 2022.

BofA Securities municipal research strategists Yingchen Li and Ian Rogow said the magnitude of this rate shock is around half that of the market crash in March 2020. The rate shock in 2022, on the other hand, will last longer and beyond the first quarter, whereas the triple-A rate shock in March 2020 was brief.

By the end of March 2020, 60% of the triple-A rate shock had been recovered and 100% by the end of May. Thus, the rate shock in 2022 will be significantly more analogous to the taper tantrum of 2013 and the Trump election victory rate shock in the fourth quarter of 2016, they said.

“If so, we look for signs of market improvement in April and possibly a strong recovery for the rest of the year,” they said.

Muni yields did not move in lockstep with Treasuries this week, with the 10-year yield decreasing 25 basis points from a high of 2.55% earlier in the week, but BofA Securities strategists said the fundamental market dynamics have obviously improved with increased muni-UST ratios across the curve. The 30-year ratio is presently at 105%, while the 10-year ratio is at 93%, according to ICE Data Services.

“While this performance is disappointing, there are encouraging signs, including $10 billion of issuance volume this week and rising secondary market activity, despite continued mutual funds outflows,” they said.

The total amount of principal and coupon redemptions in the first quarter was $113 billion. After a $20 billion outflow from mutual funds, supply and demand were about balanced, according to Li and Rogow. The cash buffer of mutual funds is unlikely to be as large as it was at the start of 2022. Unless mutual fund flows improve, they said supply/demand in April may remain unfavorable. In April, they expect $40 billion of issuance and $31 billion of principal and coupon redemptions.

Thirty-day visible supply sits at $16.91 billion and supply is slated to be $10.166 billion for the first week of April, with $8.982 billion of negotiated deals and $1.184 billion of competitive loans.

The larger primary calendar is led by $1.4 billion of tax-exempt Terminal 4 John F. Kennedy International Airport Project special facilities revenue bonds from the New York Transportation Development Corporation, $1.2 billion of taxable Dallas Fort Worth International Airport joint revenue improvement bonds from the cities of Dallas and Fort Worth, Texas and $1 billion deal from the Triborough Bridge and Tunnel Authority.

The Virginia Public Building Authority is expected to come with $465.7 million in three deals and Eugene School District #4J, Oregon with $120 million in the competitive calendar.

After April, BofA strategists said the supply/demand situation appears to be quite advantageous from May to August. At this point, they said mutual fund inflows appear to be the last missing ingredient since other market players are beginning to acquire tax-exempt munis. While mutual fund outflows may take some time to reverse, high net worth retail, cross-over accounts and insurance firms should be able to fill the gap. Mutual fund flows will be a lagging sign.

“Only when the market level has recovered some or at least stabilized for a few weeks, should mutual funds flow turn positive,” they said.

Secondary trading

North Carolina 5s of 2023 at 1.58%-1.40% versus 1.60% Thursday. Mecklenburg County, North Carolina 5s of 2024 at 1.78%-1.76%. North Carolina 5s of 2024 at 1.82%-1.81%. Maryland 5s of 2025 at 1.93% versus 1.72% on 3/22 and 1.57%-1.64% on 3/21. Baltimore County, Maryland 5s of 2026 at 2.00%.

Maryland 5s of 2028 at 2.03% versus 2.11% Wednesday and 2.14%-2.16% Tuesday. Mecklenburg County, North Carolina 5s of 2028 at 2.06%. Minnesota 5s of 2029 at 2.11%-2.10% versus 2.14%-2.12% Thursday.

Baltimore County, Maryland 5s of 2030 at 2.33%-2.34% versus 2.23% on 3/16 and 1.85% original. California 5s of 2030 at 2.28%-2.26% versus 2.30%-2.23% Thursday and 2.22% on 3/22. Washington 5s of 2032 at 2.31%-2.30% versus 2.34%-2.33% on 3/24.

NYC TFA 5s of 2039 at 2.92%-2.91% versus 3.07% original. LA DPW 5s of 2041 at 2.70% versus 2.68% Thursday and 2.92%-2.79% original.

NYC TFA 5s of 2047 at 3.13%-3.08% versus 3.27% original. LA DPW 5s of 2047 at 2.77% versus 2.83%-2.81% and 2.99%-2.86% original. NYC TFA 4s of 2051 at 3.43%-3.40% versus 3.61% original. NYC TFA 5s of 2051 at 3.24%-3.15% versus 3.31% original.

AAA scales
Refinitiv MMD’s scale was cut up to one to two basis point cuts inside the five-year at the 3 p.m. read: the one-year at 1.57% (+2 April roll) and 1.77% in two years (+1 April roll). The five-year at 1.98% (+1 April roll), the 10-year at 2.18% (unch, no roll) and the 30-year at 2.53% (unch).

The ICE municipal yield curve was mixed: 1.54% (unch) in 2023 and 1.80% (unch) in 2024. The five-year at 1.96% (+1), the 10-year was at 2.21% (unch) and the 30-year yield was at 2.58% (-1) in a 4 p.m. read.

The IHS Markit municipal curve was bumped up to two basis points: 1.52% (unch) in 2023 and 1.74% (unch) in 2024. The five-year at 1.97% (-2), the 10-year at 2.17% (-2) and the 30-year at 2.57% (-2) at a 4 p.m. read.

Bloomberg BVAL was cut a basis point: 1.53% (+1) in 2023 and 1.77% (+1) in 2024. The five-year at 2.00% (unch), the 10-year at 2.22% (unch) and the 30-year at 2.55% (+1) at a 4 p.m. read.

Treasury yields rose and equities ended in the black.

The two-year UST was yielding 2.453% (+11), the three-year was at 2.644% (+11), five-year at 2.560% (+10), the seven-year 2.496% (+7), the 10-year yielding 2.378% (+4), and the 30-year Treasury was yielding 2.427% at the close.

Analysts see 50 bps hikes
Data seems to confirm that the labor market is extremely tight, as Federal Reserve Board Chair Jerome Powell has stated.

In the March employment report, 431,000 jobs were added, the unemployment rate at 3.6%, and average hourly earnings were up 0.4% for the month and 5.5% for the year.

 “Nothing in today’s report is likely to deter the Fed from its current path of rapid rate hikes,” said Jesse Wheeler, Morning Consult economic analyst.

 But, Marvin Loh, senior macro strategist at State Street Global Markets, was slightly more bullish. “From a monetary policy perspective, this jobs report provides the Fed with a green light to continue tightening and raises the odds of a 50-bps hike at any/or all of the next few meetings.”

The Fed sees the labor market “as fully healed and continued gains without large increases in the size of the overall workforce may be viewed as overheating. Yields are generally higher following the employment report, while the curve is now solidly inverting, as investors consider whether the Fed needs to significantly slow growth to rein in inflation.”

Despite an ongoing shortage of workers, ING Chief International Economist James Knightley said, the gain in nonfarm payrolls “remains impressive.”

 The shortage of workers “will keep inflation higher for longer,” he said, “and supports the view that the Fed is set to embark on a series of 50bp rate hikes.”

 The fed funds rate target could hit 3%, Knightley said, “but rapid-fire hikes run the risk of an overshoot and we see a strong chance of corrective action again in late 2023.”

While job creation is positive, National Association of Realtors Chief Economist Lawrence Yun said, “rising wages and prices are raising the prospect of potential stagflation — similar to economic conditions in the 1970s. The bond yields are touching three-year highs in anticipation of aggressive rate hikes by the Fed.”

But, Mark Dowding, chief investment officer at BlueBay Asset Management, believes that since the Fed will combine quantitative tightening with rate hikes, “markets are now at risk of pricing too much monetary tightening in the short term.”

With inflation at levels not seen in decades, “the Fed will be more reactive to upside surprises than downside surprises over the next few months, skewing the risks to the Fed doing more, not less, than the seven hikes guided to the last meeting,” said Scott Ruesterholz, portfolio manager at Insight Investment.

And with oil prices near all-time highs, he said, “inflation may move higher still before retreating later in Q2.” But inflation will stay “well above target” into next year, Ruesterholz said.

Targeting inflation at the expense of growth, he said, “has contributed to the flattening and even inverted yield curve.”

Some models suggest an increased chance of a recession in 2023 or 2024, Dowding said. “The Fed has been relatively dismissive of the yield curve as a recession predictor, preferring to focus on the front-end spread between current cash rates and market projections of cash rates 18-months forward.”

But yield curve inversion is a tricky matter, with economists offering divergent opinions.

“While a single point of yield curve inversion can be meaningful, it also can be unpredictable (like the one we briefly experienced earlier this week) and sometimes could give false positives,” said Luis Alvarado, investment strategy analyst at Wells Fargo Investment Institute. “Thus, we prefer either four consecutive weeks of curve inversion for a given indicator and/or at least 25 basis points of inversion before concluding that the yield curve has meaningfully inverted.”

Current conditions don’t suggest “a pending recession,” he said. “However, we believe a meaningful inversion that is consistent with our highest conviction yield curve indicators could foreshadow a potentially more challenging economic environment.”

And while that point has yet to be reached, Alvarado added, “this cycle has definitely moved faster than previous cycles.”

A 10-year/one-year curve inversion would signal a recession within 18 months, Alvarado said.

Primary to come:
The New York Transportation Development Corporation (Baa1//BBB//) is set to price Tuesday $1.355 billion of tax-exempt/alternative minimum tax Terminal 4 John F. Kennedy International Airport Project special facilities revenue bonds, Series 2022. J.P. Morgan Securities.

The Cities of Dallas and Fort Worth, Texas (A1/A+/A+/AA/) is set to price Wednesday $1.188 billion of taxable Dallas Fort Worth International Airport joint revenue improvement bonds, Series 2022A, terms 2051 and 2051. Citigroup Global Markets.

The Triborough Bridge and Tunnel Authority (/AA+/AA+/AA+/) is set to price Tuesday $1 billion of forward delivery payroll mobility tax senior lien refunding bonds, Series 2022B, serials 2023-2042. Jefferies.

The New York Power Authority (A1/AA//) is set to price Tuesday $626.465 million of green transmission project revenue bonds, Series 2022A, insured by Assured Guaranty Municipal Corp. Goldman Sachs.

The Maryland Economic Development Corporation (Baa3//BBB/) is set to price Wednesday $625.425 million of green Purple Line Light Rail Project private activity revenue bonds, consisting of $100 million of Series 2022A and $525.425 million of Series 2022B. J.P. Morgan Securities.

The Allegheny County Hospital Development Authority, Pennsylvania (A2/A/A/) is set to price Tuesday $400 million of University of Pittsburgh Medical Center revenue bonds, Series 2017D-2, consisting of: $9.600 million of Series D2-A, $9.985 million of Series D2-B, $10.385 million of Series D2-C, $10.800 million of Series D2-D, $11.235 million of Series D2-E, $11.690 million of Series D2-F and $336.305 million of Series D2-G. J.P. Morgan Securities.

El Paso, Texas (/AA+/AA+/) is set to price Thursday $356.325 million of water and sewer revenue improvement and refunding bonds, Series 2022, serials 2023-2052. Ramirez & Co.

The Missouri Health and Educational Facilities Authority (A1/AA-/AA-/) is set to price Thursday $323.510 million of SSM Health health facilities revenue bonds, serials 2025-2034, terms 2047 and 2052. RBC Capital Markets.

The Board of Regents of the University of Texas System (Aaa/AAA/AAA/) is set to price Tuesday $302.045 million of revenue financing system bonds, Series 2022A. Morgan Stanley.

The Massachusetts Bay Transportation Authority (/AAA/AAA/) is set to price Tuesday $290.820 million of sustainability refunding assessment bonds, 2022 Series A, consisting of: $185.905 million of Series A-1, serials 2022-2023 and 2028-2041 and $104.915 million of Series A-2, term 2052. Wells Fargo Bank.

The Pennsylvania Economic Development Financing Authority (A2/A/A/) is set to price Tuesday $211.505 million of University of Pittsburgh Medical Center revenue and refunding bonds, Series 2022A, serials 2023-2052. RBC Capital Markets.

The authority (A2/A/A/) is also set to price Tuesday $135 million of University of Pittsburgh Medical Center revenue bonds, Series 2017C, consisting of $3.240 million of Series C-1, $3.370 million of Series C-2, $3.505 million of Series C-3, $3.645 million of Series C-4 and $121.240 million of Series C-5. J.P. Morgan Securities.

The Monroeville Finance Authority, Pennsylvania (A2/A/A/) is set to price Tuesday $172.900 million of University of Pittsburgh Medical Center revenue bonds, Series 2022B, serials 2023-2024 and 2028-2042. Barclays Capital.

The San Jose Financing Authority (Aa3/AA/AA//) is set to price Thursday $165.795 million of taxable Convention Center Refunding Project lease revenue bonds, Series 2022A. Morgan Stanley.

The Chino Valley Unified School District, California (Aa2/AA-//) is set to price Wednesday $148.205 million, consisting of $75 million of current interest bonds, serials 2023-2027 and 2033-2041, terms 2046, 2051 and 2055; $65 million of capital appreciation bonds, serials 2028-2046; and $8.205 million of refunding bonds, serials 2022-2023 and 2025-2027. Stifel, Nicolaus & Co.

The Illinois Housing Development Authority (Aaa////) is set to price Tuesday $125 million of social non-alternative minimum tax revenue and refunding bonds, 2022 Series A, serials 2022-2034, terms 2037, 2044 and 2052. Wells Fargo Bank.

The Florida Development Finance Corporation (/BBB//) is set to price Thursday $121.535 million of Mater Academy Projects educational facilities revenue bonds, Series 2022, serials 2025-2056. PNC Capital Markets.

Hempfield Area School District, Pennsylvania (/AA//) is set to price Thursday $115.035 million of general obligation refunding bonds, consisting of $475,000 of Series A, serial 2025, $6.040 million of Series B, serials 2023-2027 and $108.520 million of Series 1, serials 2027-2047. PNC Capital Markets.

The Dormitory Authority of the State of New York (//BBB-//) is set to price next week $110 million of Wagner College revenue bonds, Series 2022. Morgan Stanley.

The Henrico County Economic Development Authority, Virginia (//A-//) is set to price Wednesday $103.995 million of Westminster Canterbury Richmond residential care facility revenue bonds, Series 2022A. Ziegler.

Competitive:
Eugene School District #4J, Oregon (Aa1///) is set to sell $120 million of Oregon School Bond Guaranty general obligation bonds, Series 2022, at noon eastern Tuesday.

The Virginia Public Building Authority (Aa1/AA+/AA+/) is set to sell $20.065 million of taxable public facilities revenue bonds, Series 2022B, at 11:30 a.m. Tuesday; $199.995 million of public facilities revenue bonds, Series 2022A Bidding Group 2, at 11 a.m. Tuesday and $236.655 million of public facilities revenue bonds, Series 2022A Bidding Group 1, at 10:30 a.m. Tuesday.