Weaker tone on front end ahead of FOMC, but technicals strong heading into yearend

Municipals were weaker on the short end Friday ahead of a smaller new-issue calendar made up largely of a Pennsylvania public-private partnership deal. U.S. Treasuries saw losses along the curve and equities ended the week in the red as markets digested more mixed economic data ahead of the Federal Open Market Committee meeting next week where the Fed is expected to hike rates 50 basis points.

Triple-A yields rose up to 10 basis points on the one-year and saw little movement outside of the short end, while UST yields climbed three up front and sold off up to 14 on the long bond.

Muni to UST ratios were little changed. The three-year muni-UST ratio was at 59%, the five-year at 66%, the 10-year at 70% and the 30-year at 100%, according to Refinitiv MMD’s 3 p.m. read. ICE Data Services had the three at 61%, the five at 65%, the 10 at 75% and the 30 at 101% at a 4 p.m. read. 

U.S. stocks settled higher after “a mixed round of pricing data seemed unlikely to change what the Fed will do next week,” said Edward Moya, senior market analyst at OANDA.

Stocks are finishing “a down week on a positive note as expectations remain high that the Fed will downshift to a slower pace,” he said.

“Inflation is heading lower but we won’t know for a couple of quarters if more tightening will be required by the Fed,” Moya said. “For now, investors appear confident that the Fed will stop tightening once the terminal rate peaks around the 5.00% to 5.25% levels.”

The tone in the municipal market on Friday was mixed depending on the area of the yield curve compared with a weaker Treasury backdrop, according to Jeff Lipton, managing director and head of municipal credit and market strategy and municipal capital markets at Oppenheimer & Co.

“In our view, it would likely take a surprisingly hot inflation print and more hawkish Fed-speak to undermine the positive tone for munis,” Lipton said. “The FOMC is expected to lift the funds rate by 50 basis points and market participants will be closely following Chair Powell’s post-meeting press conference looking for any indication of a softer rate hike outlook.”

The December Federal Open Market Committee meeting “will be the highlight of next week, and probably the remainder of the year,” said Barclays strategists Mikhail Foux, Clare Pickering and Mayur Patel in a weekly report.

Barclays economists predict the Fed will hike rates 50 basis points, with only a “minuscule risk” of continuing with 75 basis points rate hikes if there is a robust consumer price index print next week. Friday’s higher-than-expected producer price index “reinforces the importance of the CPI release on Tuesday,” they said.

BofA strategists said the Fed can “continue to afford a strong policy posture as long as the economy is not in a recession and the labor market remains strong.”

At the same time, they said inflation data has been easing, noting “additional evidence of that came this week, with a large decline in unit labor costs that carried the bond market rally further to scales definitively larger than in June and July.”

Ten-year to 30- year UST yields fell almost 100 basis points from their October peaks as 10- to 30-year triple-A benchmarks fell 70 basis points to 85 points. 

“All of this suggests that the bond market rally likely has already been under way since late October/early November,” BofA strategists said.

The year-end muni rally continued in December, helped by falling UST yields, Barclays strategists said.

After the rate rally started in November, investment grade munis have the “returned 5.5%, and the [high-yield] index generated 7.3%,” they said. In any other year, they said, “this excellent performance could have made the whole year, but in 2022, the IG index is still down nearly 9% and the HY index nearly 13%; both are still on par with some of the worst-ever years since the inception of both indexes.”

Barclays strategists said they “are cautious about market performance in 1Q23” and would not be  surprised if “munis continue doing well for the next couple of weeks.”

“Dealer inventories have meaningfully declined, supply has remained subdued, with probably just one active week left this year, most investors are still in buying mode … and some tax-exempts and taxables actually look attractive versus Treasuries and corporates,” they said.

The muni rally should do well in the first strong supply/demand season from December through February, they said.

“While March and April may still produce some backup in rates due to tax season, the Fed likely will be at its endgame by then,” they said.

Principal redemption and coupon payments are about $44 billion for December, according to BofA strategists.

“Total issuance for the month will be low due to the Fed meeting and then the holidays, making the demand/supply imbalance quite acute at a time when the market is doing well,” they said. “The availability of bonds becomes a real issue as investors tend to keep the bonds they currently hold.”

BofA strategists said it does not look “like there is any relief of this imbalance until perhaps March when issuance is usually large, but redemptions are somewhat less.” They expect $26 billion of issuance in January 2023 and $32 billion in February issuance against $42 billion and $45 billion of principal and coupon redemptions, respectively. 

These data suggest that munis will generally perform well even if USTs don’t, and muni-USTs ratios will remain low for the December through February season, BofA strategists said.

For municipals, “technicals continue to support the municipal market and we expect this to extend through the remainder of December and into early next year as reinvestment needs are likely to be pronounced,” Lipton said.

Oppenheimer’s investment thesis for 2023 continues to focus on the yield and income opportunities available within municipal bonds, according to Lipton.

“Such compelling attributes support portfolio realignment as municipal securities have emerged as the asset class du jour for those investors seeking tax-efficiency, above-average credit quality in support of capital preservation, and portfolio diversification,” he added.

In the primary Friday, J.P. Morgan Securities priced for the Louisiana Local Government Environmental Facilities and Community Development Authority (Aa1/AAA//) $209.300 million of taxable Louisiana Utilities Restoration Corporation Project/ENO storm recovery bonds, Series 2022, with 5.197s of 9/2039 at par, noncall.

Calendar stands at $3.2B
Investors will be greeted Monday with a new-issue calendar estimated at $3.214 billion.

There are $2.777 billion of negotiated deals on tap and $437.5 million on the competitive calendar.

The negotiated calendar is led by $1.9 billion of tax-exempt private activity revenue bonds from the Pennsylvania Economic Development Financing Authority, which will mark the largest issuance to date of PABs under the Department of Transportation’s allocation for surface transportation projects.

The debt is part of a high-profile public private program to rebuild bridges across the commonwealth.

The next largest deal is $254 million of taxable single-family mortgage bonds from the Idaho Housing and Finance Association.

The Clearview Regional High School District Board of Education, New Jersey, leads the competitive calendar with $59.094 million of school bonds.

Muni CUSIP requests increase
Municipal request volume increased in November, following an increase in September, according to CUSIP Global Services. For muni bonds specifically, there was an increase of 14.8% month-over-month but a 23.8% decrease year-over-year.

The aggregate total of identifier requests for new municipal securities, including municipal bonds, long-term and short-term notes, and commercial paper, rose 10.5% versus October totals. On a year-over-year basis, overall municipal volumes were down 19.7%.

Secondary trading
Connecticut special tax 5s of 2023 at 2.52%. New York City 5s of 2023 at 2.56%-2.55%. Texas 5s of 2023 at 2.56%. Washington 5s of 2023 at 2.40%. Montgomery County, Maryland, 5s of 2023 at 2.57%.

California 5s of 2024 at 2.42%. Prince George’s County, Maryland, 5s of 2024 2.47%. Ohio common schools 5s of 2025 at 2.50% versus 2.48% Thursday. New York City TFA 5s of 2025 at 2.46%-2.44%.

Wisconsin 5s of 2030 at 2.56%-2.54%. Delaware 5s of 2031 at 2.49%-2.48% versus 2.58%-2.56% Monday.

Mecklenburg County, North Carolina, 5s of 2035 at 2.80%-2.78% versus 2.82%-2.81% Thursday. New York Dorm PITs 5s of 2036 at 3.17%-3.15%.

Massachusetts transportation 5s of 2052 at 3.75%-3.74%.

AAA scales
Refinitiv MMD’s scale was cut 10 basis points at one-year: the one-year at 2.49% (+10) and 2.44% (+3) in two years. The five-year at 2.47% (unch), the 10-year at 2.51% (-2) and the 30-year at 3.46% (unch).

The ICE AAA yield curve was weaker: 2.43% (+2) in 2023 and 2.44% (+2) in 2024. The five-year at 2.47% (+2), the 10-year was at 2.60% (+2) and the 30-year yield was at 3.49% (+2) at 4 p.m.

The IHS Markit municipal curve saw cuts of up to 10 on the front end: 2.47% (+10) in 2023 and 2.44% (+3) in 2024. The five-year was at 2.48% (unch), the 10-year was at 2.52% (unch) and the 30-year yield was at 3.44% (unch) at a 4 p.m. read.

Bloomberg BVAL was weaker on the front end: 2.49% (+8) in 2023 and 2.47% (+4) in 2024. The five-year at 2.48% (+1), the 10-year at 2.57% (unch) and the 30-year at 3.45% (+1) at 4 p.m.

Treasuries saw losses out long.

The two-year UST was yielding 4.338% (+3), the three-year was at 4.094% (+4), the five-year at 3.763% (+5), the seven-year 3.694% (+7), the 10-year yielding 3.576% (+10), the 20-year at 3.876% (+13) and the 30-year Treasury was yielding 3.567% (+14) at the close.

PPI comes in higher than expected
Despite the Federal Reserve’s months-long attempts to combat inflation by raising interest rates, a key inflation indicator showed price pressures dropped slightly but remained stubbornly high in November.

The Producer Price Index increased 7.4% year-over-year and “upward revisions to October’s PPI strengthened the inflationary tone of the report,” said Mickey Levy and Mahmoud Abu Ghzalah of Berenberg Capital Markets.

Continued robust price increases across core goods PPI categories and a re-acceleration in services prices “are consistent with more entrenched inflationary pressures, particularly given the pickup in nominal wages and elevated measures of near-term household inflationary expectations,” they said.

“Taken together, November’s PPI suggests that while some inflationary pressures have peaked or begun to moderate, the disinflationary process remains at an early stage, with signs thus far suggesting inflation is likely to recede to the Fed’s 2% target only gradually,” they noted.

“Clearly inflationary pressures are abating, from input costs to supply chain pressures, and in some cases demand and wages,” said Matt Peron, director of research at Janus Henderson Investors. “However, that is not yet being reflected in the official inflation statistics, including this morning’s PPI.”

He said, “this may keep some pressure on the Fed to maintain higher policy rates and as a result will pressure equity prices in the near term.” He noted he is cautious “on risk assets until the inflation picture and upcoming reset in corporate earnings is resolved,” though he does “see light at the end of the tunnel in the coming months.”

Primary to come:
The Pennsylvania Economic Development Financing Authority (Baa2//BBB-/) is set to price Tuesday $1.882 billion of tax-exempt AMT Penndot Major Bridges Package One Project private activity revenue bonds, serials 2029-2033, terms 2034, 2035, 2036, 2037, 2038, 2039, 2040, 2041, 2042, 2047, 2052, 2057 and 2062. Wells Fargo Bank.

The Idaho Housing and Finance Association (Aa1///) is set to price Thursday $253.615 million of taxable single family mortgage bonds, 2022 Series A, serials 2023-2035, terms 2038, 2043, 2048 and 2053. Barclays Capital.

Competitive:
The Clearview Regional High School District Board of Education, New Jersey (/AA//) is set to sell $59.094 million of school bonds, Series 2022, at 11 a.m. eastern Wednesday.

Christine Albano contributed to this story.