Munis outperform UST rout after hotter-than-expected jobs report

Municipals were hit hard across the curve Friday, with the most damage felt on the short end. Triple-A benchmarks outperformed a U.S. Treasury rout on the heels of a hotter-than-expected jobs report.

Triple-A benchmarks were cut six to 15 basis points at the one-year, with smaller cuts across the curve. U.S. Treasury yields rose eight to 21 basis points.

The three-year muni-UST ratio was at 54%, the five-year at 56%, the 10-year at 62% and the 30-year at 87%, according to Refinitiv MMD’s 3 p.m. ET read. ICE Data Services had the three at 55%, the five at 58%, the 10 at 64% and the 30 at 90% at 4 p.m.

Going into this week’s Federal Open Market Committee meeting, a 25-basis point hike for the fed funds rate “was largely priced in and the Fed lived up to market expectations, slowing the pace of rate hikes from prior meetings,” said Barclays strategists Mikhail Foux, Clare Pickering and Mayur Patel.

Barclays economists see Fed Chair Jerome Powell’s “comments on the divergence between FOMC fed fund rate projections and market expectations as the Fed not being as hawkish as in the past.”

They think if inflation “continues to moderate and the FOMC lowers its inflation expectations, this would open the door to rate cuts later in the year.”

“The market interpreted the comments in a similar fashion, with Treasuries rallying 15-20bp over the past two days, prior to [Friday’s] selloff,” they said.

The Barclays strategists believe there will be two more 25bp hikes in March and May, and “once inflation prints moderate towards the end of the year, two 25bp cuts in November and December.”

The cuts later in the year, they said, “would prevent the real fed funds rate from becoming elevated during a period of slower economic growth and weaker labor market conditions.”

Fed fund futures have been pricing “a faster pace of rate cuts, which should start later in the year,” they noted.

Friday’s payrolls “surprised to the upside, with nonfarm payrolls increasing 517,000 last month after an upwardly revised 260,000 gain in December,” the Barclays strategists said.

“The unemployment rate dropped to 3.4%, the lowest since May 1969 and average hourly earnings grew at a steady clip,” they said. “USTs sold off 10-15bp on the back of this data release.”

Prior to jobs report data release, “the UST rally this week also helped munis, with the municipal yield curve bull flattening,” they said.

“Ratios generally cheapened across the curve this week as munis lagged Treasuries, although they still remain rich to historical levels, especially the 5-10y part of the curve, largely due to [separately managed account] demand, which is likely to keep valuations anchored in those tenors,” they said.

“The yield curve is likely to continue flattening as investors might want to extend duration and look to deploy capital amid supportive muni market technicals and lower UST volatility,” according to the Barclays strategists.

Helped by subdued primary activity in January, trading volumes were solid, with the fourth-highest level in January going back to 2010, they said. Given the expected low supply calendar in February, they think secondary trading volumes will remain robust this month as well.

The taxable muni market did well in January supported by technicals. Taxable supply was only $2 billion for bonds issued with a muni CUSIP, and just $4 million for those issued with a corporate CUSIP.

“Corporates rallied in January despite a very heavy primary calendar, but taxable munis outperformed them — long U.S. corporate spreads were 12bp tighter m/m, while taxable muni spreads were 19bp tighter m/m,” they said.

Secondary trading
Maryland 5s of 2024 at 2.39%. Washington 5s of 2024 at 2.43%. Ohio 5s of 2024 at 2.45%.

Georgia 5s of 2025 at 2.25%. Maryland 5s of 2025 at 2.25%. California 5s of 2026 at 2.09%-2.19% versus 2.25% on 1/10.

NYS Environmental Facilities Corp. 5s of 2031 at 2.02%. Fairfax County, Virginia, 4s of 2032 at 2.21%-2.20% versus 2.35% on 1/23 and 2.37% on 1/20. Washington 4s of 2033 at 2.48%-2.44%.

Triborough Bridge and Tunnel Authority 5s of 2047 at 3.51%-3.55% versus 3.66% Wednesday and 3.72% Monday. Massachusetts 5s of 2048 at 3.51%-3.50% versus 3.47% Thursday and 3.37% on 1/20. LA DWP 5s of 2052 at 3.18%-3.30% versus 3.40%-3.41% Tuesday and 3.42% on 1/27.

AAA scales
Refinitiv MMD’s scale was cut four to 15 basis points. The one-year was at 2.42% (+15) and 2.19% (+5) in two years. The five-year was at 2.04% (+5), the 10-year at 2.18% (+5) and the 30-year at 3.17% (+4) at 3 p.m.

The ICE AAA yield curve was cut four to six basis points: at 2.34% (+6) in 2024 and 2.24% (+5) in 2025. The five-year was at 2.04% (+4), the 10-year was at 2.14% (+4) and the 30-year yield was at 3.01% (+4) at 4 p.m.

The IHS Markit municipal curve was cut five to 15 basis points: 2.44% (+15) in 2024 and 2.19% (+5) in 2025. The five-year was at 2.09% (+5), the 10-year was at 2.18% (+5) and the 30-year yield was at 3.16% (+5) at a 4 p.m. read.

Bloomberg BVAL was cut four to 13 basis points: 2.42% (+13) in 2024 and 2.16% (+4) in 2025. The five-year at 2.08% (+5), the 10-year at 2.21% (+5) and the 30-year at 3.22% (+5).

Treasuries were little changed.

The two-year UST was yielding 4.307% (+21), the three-year was at 3.964% (+19), the five-year at 3.669% (+18), the seven-year at 3.605% (+16), the 10-year at 3.534% (+14), the 20-year at 3.767% (+10) and the 30-year Treasury was yielding 3.629% (+8) at 4 p.m.

Jobs report
January’s jobs report came in hotter than expected as nonfarm payrolls increased by 517,000, above Dow Jones’ estimate of 187,000 additions.

“Overall, the data completely upends a few market narratives than have been popular to start 2023,” said Payden & Rygel principal and chief economist Jeffrey Cleveland.

The report doesn’t support expectations of an imminent recession, he said. “To the contrary, the U.S. economy is arguably still booming based on the jobs data,” Cleveland said.

While monthly jobs gains won’t continue at this level, he said, even 200,000-plus per month would be considered strong.

While disinflation may have begun, Edward Moya, senior market analyst at OANDA, said, “a strong labor market may prove troubling for bets for inflation to continue to drop quickly.”

The market expects rate cuts by the end of the year, but, he said investors “might be in for a rude awakening. We won’t see linear moves with inflation trends and that should make it unlikely for inflation to be at low enough levels to justify rate cuts.”

“Even allowing for the fact that payrolls is probably now a lagging indicator of the current state of the economy, this number suggests the service sector maybe holding up better than other recent indicators have been suggesting,” said Fitch Chief Economist Brian Coulton.

But not everyone bought into the report. “Something isn’t quite right when you look under the hood,” said Morning Consult chief economist John Leer. “January’s data was heavily impacted by annual updates to the [Bureau of Labor Statistics] methodology, making monthly comparisons less meaningful for understanding where we are in the employment cycle,” he said.

The pandemic “dramatically affected the number and types of businesses operating in the U.S., and the BLS is still trying to understand how to account for those changes in its monthly release,” Leer said.

“I wouldn’t totally throw out today’s data, but I also wouldn’t take it at face value,” he said.

“We’ve heard a lot in recent days about the Fed pausing and maybe even pivoting on monetary policy to ease rates later this year,” Payden’s Cleveland said. Based on the data, he noted that shift seems very unlikely. “We think the bar to easing policy is very high,” he said.

“The Fed is going to have a lot of trouble not raising rates again next month and probably after that as well as unemployment shows no sign currently of rising,” said Arthur Laffer, Jr., president at Laffer Tengler Investments. Not only did unemployment fall a tick to 3.4%, but gains were broadbased.

The report “will give the Fed absolutely no reassurance that labor market imbalances — which have been adding to wage pressures — are easing,” Coulton said. In combination “with the pick-up in job openings, stubbornly low workforce participation and the reacceleration in hourly wages on a three-month basis, it will reinforce the message that the Fed still has quite a lot of work to do to tame core inflation,” he said.

Wells Fargo Securities Senior Economist Sarah House and Economist Michael Pugliese suspect “members of the FOMC will take January’s blowout employment report with somewhat of a grain of salt.”

But, they noted “it will be hard to completely ignore the reading at a time when policymakers want to ensure that their policies help durably return inflation to 2%.”

The growth in average hourly earnings, they said, “adds to the case for remaining vigilant in the inflation fight.”

Markets appear “to be in agreement with our forecast that another 25 bps hike is probable at the March 22 FOMC meeting, pricing in a 93% chance of a rate hike,” the Wells Fargo economists said.

“There is still plenty of additional economic data between now and the March FOMC meeting, including another employment report and two more consumer price index reports, but even after accounting for the flattening seasonal effect on January payrolls, today’s report argues for the Federal Reserve to stay in a hawkish mood,” House and Pugliese said.

“In isolation, the report justifies the Fed’s aggressive policy stance thus far,” said Alexandra Wilson-Elizondo, head of multi-asset retail investing at Goldman Sachs Asset Management. “The report will make insurance cuts less likely as there are no material signs of stress to force a rate cut.”

The Fed now has “more room to allow for stagnation in the macro economy and risk remains skewed to over-tightening,” which, if done, will push the U.S. into recession.

Given the Fed is data-dependent, Friday’s release is “more telling about forward policy than the FOMC meeting,” Wilson-Elizondo said. “It puts the December SEP forecasts back on the table, which showed more hikes and higher for longer.”

The report “bolsters the market expectation for a soft-landing, which we believe has been the largest driver of early 2023 gains in U.S. equities,” said James Ragan, D.A. Davidson director of Wealth Management Research.

Additionally, he said, it “validates the Fed’s view that ongoing increases in the fed funds interest rate target are appropriate. We had believed that ongoing hikes in the fed funds target increased the risk of a policy mistake, as the lag effect from many of the 2022 rate hikes still had not taken hold, it appears that the 425 basis points of rate hikes in 2022 have done very little to bring more balance to the labor market.”

Primary to come
New issuance is estimated at $4.49 billion in the week of Feb. 6, up from revised sales of $277.6 million in the Jan. 30 week.

The upcoming calendar includes an estimated $3.61 billion of negotiated offerings, according to Ipreo and The Bond Buyer, compared to a revised $99.7 million for the Jan. 30 week, according to Refinitiv MMD.

Competitive volume is estimated at $876.6 million compared with $122.9 million for the Jan. 30 week.

The negotiated calendar will be dominated by a $1.09 billion New York City Transitional Finance Authority offering on Wednesday, as well as a handful of Texas school deals. The NYC TFA’s future tax secured subordinated bond offering includes fiscal 2023 Series E subseries E-1 tax-exempt bonds that mature serially from 2024 to 2041. BofA Securities will be the lead book runner.

The NYC TFA will also dominate the competitive calendar with a $119.8 million revenue sale on Wednesday.

The Lamar Consolidated Independent School District, Texas will sell $648.6 million of school district unlimited tax schoolhouse bonds. The structure will include Series 2023 bonds rated Aa3 by Moody’s and AA by Standard & Poor’s maturing serially between 2024 and 2058. Raymond James & Associates Inc. will be the bookrunning senior manager for the Wednesday pricing. 

The Massachusetts Development Finance Agency is slated to sell $229.19 million of revenue bonds on Thursday. The refunding bonds, which are rated Baa2 by Moody’s and BBB by Standard & Poor’s, are being sold on behalf of Boston Medical Center. The Series G 2023 sustainability bonds will mature serially from 2023 to 2029, with term maturities in 2048 and 2052. RBC Capital Markets is the lead bookrunner.

Elsewhere in Texas, the Magnolia Independent School District is planning a Tuesday sale of $228 million of unlimited tax school building bonds on behalf of Montgomery County. The Series 2023 bonds are rated Aa2 by Moody’s. FHN Financial Capital Markets is the senior bookrunner.

The Troy School District, Michigan, on Tuesday will price a $174.9 million sale of unlimited tax general obligation bonds. The sale, on behalf of Oakland County, is insured by the state of Michigan School Building Qualified Loan Program. The structure includes serial bonds maturing from 2024 to 2052. Stifel, Nicolaus & Co. will be bookrunner.

The Little Elm Independent School District, Texas, is bringing a $173.9 million offering of unlimited tax school building bonds on Wednesday. The bonds, which are rated AA-minus by Standard & Poor’s, are structured as serial bonds from 2026 to 2043, and term bonds in 2048 and 2053. Bok Financial Securities Inc. is the lead bookrunner.

The Johnson County Unified School District, Kansas, on Wednesday is selling $137.5 million of general obligation bonds on behalf of Shawnee Mission School District #512. The structure includes $132 million in Series 2023 A maturing serially from 2024 to 2043, and $5.46 million of Series 2023 B refunding bonds maturing from 2024 to 2026. Stifel, Nicolaus & Co. is the lead bookrunner.

The Massachusetts Housing Finance Agency is slated to sell $132.96 million of housing bonds on Wednesday. Rated Aa2 by Moody’s and AA-plus by Standard & Poor’s, the non-AMT sustainability bonds will consist of $46.87 million of Series A1 bonds and $86.09 million Series A3. Series A1 matures serially from 2025 to 2035, with terms in 2038, 2044, 2048, 2053, 2058, and 2065, while Series A3 matures serially from 2024 to 2027. UBS is the lead bookrunner. 

The Florida Housing Finance Corp., meanwhile, is slated to sell $130 million of homeowner mortgage revenue bonds on Wednesday. The bonds are rated AAA by Standard & Poor’s and are structured as Series 1 non-AMT bonds maturing serially from 2025-2035, with terms in 2038, 2043, 2048, 2053, and 2054. RBC Capital Markets is the senior manager.

The Health Care Authority for Baptist Health, an affiliate of UAB Health System, will issue $119.19 million of refunding bonds on Thursday. The Series 2023 bonds are slated to mature serially from 2023 to 2037 and are rated A3 by Moody’s and BBB-plus rated by Standard & Poor’s. Morgan Stanley & Co. will senior manager the deal.

Christine Albano contributed to this story.