USTs rally on intensifying recession concerns, munis underperform

“Yield curve inversion deepens and nears a four-decade low which is clearly setting up this economy for a recession that won’t be a mild one,” Moya said.

Municipal to UST ratios out long rose again. The three-year muni-UST ratio was at 61%, the five-year at 68%, the 10-year at 74% and the 30-year at 101%, according to Refinitiv MMD’s 3 p.m. read. ICE Data Services had the three at 59%, the five at 64%, the 10 at 74% and the 30 at 98% at a 4 p.m. read. 

In the primary Wednesday, Wells Fargo Bank priced for the Virginia Small Business Financing Authority (Aaa///) $125 million of Pure Salmon Virginia LLC Project environmental facilities revenue bonds, Series 2022, with 3.5s of 11/2052 with a mandatory tender date of 11/1/2023 at par, callable 8/1/2023.

Outlook for 2023 improving for munis
Munis are set to end the year in “deep negative territory,”noted Vikram Rai, head of Citigroup Global Market’s Municipal Strategy group during a 2023 outlook call. However, he is bullish on munis in the near term, as historically, December and January have been supportive as coupon payments and redemptions grow.

Taxable municipal performance this year has been “heartbreaking,” he said.

“For the longest time, we would brag about taxables, but this year, they have done even worse than most tax-exempts,” he said.

Rai said taxables’ negative performance isn’t due to a supply-demand imbalance because there’s hardly any supply. He believes the negative performance can be attributed to mainly the duration and some illiquidity.

Fed funds are up 375 basis points year-to-date, with economists forecasting another 100 basis points before the Fed pauses.

“This is no surprise, given all that has gone on, that Treasuries have created an incredibly wide range,” Rai said. The 10-year UST range is around 273 basis points, the widest since 1980 when 10-year UST yields were about 8%.

Munis have followed UST volatility and triple-A yields have traded in a 236 basis point range, he said. 

Rai noted there are similarities between the market environment now versus the market environment in the 1970s and 1980s, but this hiking is “very unique.”

If the downdraft and inflation continue, he expects the rate volatility to subside.

Heading into 2023, Cooper Howard, a fixed income strategist focused on munis at Charles Schwab said, “2023 should be the year where muni bonds come back in vogue.”

“While 2022 was a brutal year for the muni market but we expect that to change in 2023,” he said. “For the first time in a long time, investors can earn appealing income on their muni bond portfolio which should begin to attract investors and bode well for total returns.”

Howard said that issuance will likely remain subdued, which is supportive of total returns.

“Issuance should continue to remain lower than average assuming that interest rates don’t fall substantially,” he said. “Historically, higher interest rates have resulted in lower issuance.”

Moreover, he said, “state and local government coffers are at record levels which lessens the needs to borrow.”

Lower issuance combined with increased demand should help muni returns in 2023, Howard noted, adding that “a positive credit outlook should also bode well for demand in 2023.”

State and local government credit quality continued to improve in 2022, and he expects “it to remain strong in 2023.”

State tax revenues have “surged to record levels and state rainy day funds are at record levels as well,” he said.

The improved financial conditions for state and local governments, he said, “have translated into ratings upgrades.”

“Defaults remain low and we don’t anticipate they will substantially increase in 2023,” Howard said.

“Although credit quality is high, we believe that we are at the peak in the economic cycle and if the economy continues to run below-trend growth, the pace of growth for state and local government tax revenues should slow too,” he said. “This likely won’t lead to an increase in defaults or downgrades but the pace of upgrades should slow.”

Howard said he’s “more cautious” on issuers that are lower rated and have revenue streams closely tied to economic growth.

Fund outflows continue
Outflows intensified with the Investment Company Institute reporting that investors pulled $2.488 billion from mutual funds in the week ending Nov. 30 after $1.733 billion of outflows the previous week.

Exchange-traded funds saw another week of inflows at $1.386 billion after $877 million of inflows the week prior, per ICI data.

Informa: Money market munis see outflows
Tax-exempt municipal money market funds saw $2.63 billion of outflows the week ending Tuesday, bringing the total assets to $107.09 billion, according to the Money Fund Report, a publication of Informa Financial Intelligence.

The average seven-day simple yield for all tax-free and municipal money-market funds rose to 1.49%,

Taxable money-fund assets inflows of $62.18 billion to end the reporting week at $4.552 trillion of total net assets. The average seven-day simple yield for all taxable reporting funds rose to 3.48%.

AAA scales
Refinitiv MMD’s scale was bumped up to two basis points: the one-year at 2.39% (unch) and 2.41% (unch) in two years. The five-year at 2.47% (-2), the 10-year at 2.53% (-2) and the 30-year at 3.46% (-2).

The ICE AAA yield curve was bumped up to four basis points: 2.39% (-2) in 2023 and 2.42% (-3) in 2024. The five-year at 2.45% (-4), the 10-year was at 2.58% (-3) and the 30-year yield was at 3.49% (-2) at 4 p.m.

The IHS Markit municipal curve was bumped two basis points: 2.37% (unch) in 2023 and 2.41% (-2) in 2024. The five-year was at 2.48% (-2), the 10-year was at 2.54% (-2) and the 30-year yield was at 3.44% (-2) at a 4 p.m. read.