Munis outperform UST selloff after GDP data shows slower growth

Municipals were weaker across the curve Thursday with the largest cuts seen on the front end, but outperformed a U.S. Treasury selloff following economic data that showed the growth in the U.S. economy slowed in the first quarter. Equities ended up.

Triple-A yields rose as much as eight basis points on the two-year while UST yields closed as much as 15 basis points higher.

The two-year muni-Treasury ratio Thursday was at 66%, the three-year at 66%, the five-year at 66%, the 10-year at 67% and the 30-year at 90%, according to Refinitiv MMD’s 3 p.m. ET read. ICE Data Services had the two-year at 67%, the three-year at 69%, the five-year at 67%, the 10-year at 69% and the 30-year at 92% at 4 p.m.

Outflows from municipal bond mutual funds receded as Refinitiv Lipper reported $92.055 million was pulled from them as of Wednesday after $2.876 billion of outflows the week prior. 

Munis had “gotten so expensive, particularly on the short end,” said Jeff Lipton, managing director of credit research at Oppenheimer Inc.

“We did see the Treasury market sell-off, and the muni market finally capitulated to the cyclical lows, on the relative value ratios,” he said.

Lipton noted the richness seen in the municipal market was unsustainable, “so that’s why we did see the sell off and the magnitude that we witnessed.”

He noted technicals are driving the municipal bond market. Munis are returning -0.11% month-to-date and 2.67% year-to-date.

The Treasury market is outperforming the muni market. Treasuries are returning 0.50% month-to-date and 3.52% year-to-date.

“So the question is will demand hold in to the extent where we’re going to see further positive performance in May for munis,” he said.

Lipton believes demand will hold up and supply will be kept at bay.

Before you know we’re going to be in the summer technical zone, where we’re going to have significant reinvestment, and that’s going to help to support favorable technicals for the muni market,” he said.

Over the next 30 days, he said there will be a slight net negative supply, but as “we move forward, we’re going to see a significantly larger net negative supply figure, and that’s going to contribute to supportive technicals for the muni market,” according to Lipton.

He said that should help to contribute to modest single-digit positive returns.

The supply and demand dynamics are likely to improve beyond the next 30-day period, and muni technicals will become even more constructive for muni performance.

“Right now, we’re in that ‘steady as she goes,’ period,” he said.

The “Fed’s blackout period began last Saturday,” Lipton said. “We haven’t heard from any of the policymakers. We’re still getting what can be viewed as mixed economic signals.”

As credit spreads are rising, there is little concern — if any — over credit risk, according to new commentary from the Charles Schwab Center for Financial Research.

“Rising credit spreads usually coincide with increased concerns about credit, but we believe credit quality is generally strong,” Cooper Howard, fixed income strategist for the firm, said in a report on Wednesday. 

“There are signs that it’s peaked, but given the strength in tax revenues since the onset of COVID, many state and local governments are in a very good position,” he said, noting that the “sweet spot” for attractive yields relative to risks is the single A and double-A-rated portions of the market.

Despite some improvement, ratios continue to trade at rich levels, he noted.

“The muni-to-Treasury ratio is at unattractive levels relative to historical averages,” Howard said.

Shorter-term triple-A municipals are at levels where many investors may be able to achieve a higher after-tax yield for Treasuries or other highly rated options, he continued.

“We would not be surprised if ratios continue to move higher, driven by an increase in supply in the near-term,” Howard said.

In the primary market, Siebert Williams Shank & Co. priced for the Greater Asheville Regional Airport Authority (Baa2///A+/) $175 million of AMT airport system revenue bonds, Series 2023, with 5s of 7/2027 at 3.47%, 5s of 2028 at 3.53%, 5s of 2033 at 3.59%, 5s of 2038 at 4.09%, 5.25s of 2043 at 4.30%, 5.25s of 2048 at 4.41% and 5.25s of 2053 at 4.47%, callable 7/1/2033.

In the competitive market, Nassau County, New York, (Aa3/AA-/A+/) sold $153.500 million of general improvement bonds to BofA Securities, with 5s of 4/2025 at 2.65%, 5s of 2028 at 2.40%, 5s of 2033 at 2.42%, 5s of 2038 at 3.15%, 4s of 2043 at 4.05%, 4s of 2047 at 4.19% and 4s of 2053 at 4.30%, callable 4/1/2033.

Secondary trading
Maine 5s of 2024 at 3.08%. Massachusetts 5s of 2024 at 2.59%-2.48%. North Carolina 5s of 2025 at 2.82%.

Virginia College Building Authority 5s of 2028 at 2.49%. Washington 5s of 2029 at 2.44%. California 5s of 2029 at 2.48%.

Ohio Water Development Authority 5s of 2031 at 2.44%. Massachusetts 5s of 2031 at 2.44%-2.40%. California 5s of 2036 at 2.89% versus 2.80% Wednesday and 2.88% on 4/21.

University of California 5s of 2043 at 3.32% versus 3.33%-3.28% Wednesday. NY State Urban Development Corp. 5s of 2050 at 3.82% versus 3.97% Wednesday.

AAA scales
Refinitiv MMD’s scale was cut two to eight basis points: The one-year was at 3.00% (+5) and 2.69% (+8) in two years. The five-year was at 2.38% (+2), the 10-year at 2.35% (+2) and the 30-year at 3.39% (+2) at 3 p.m.

The ICE AAA yield curve was cut two to seven basis points: 2.97% (+7) in 2024 and 2.68% (+5) in 2025. The five-year was at 2.37% (+4), the 10-year was at 2.34% (+4) and the 30-year was at 3.39% (+2) at 4 p.m.

The IHS Markit municipal curve was cut one to eight basis points: 2.99% (+8) in 2024 and 2.69% (+8) in 2025. The five-year was at 2.38% (+2), the 10-year was at 2.35% (+2) and the 30-year yield was at 3.39% (+1), according to a 4 p.m. read.

Bloomberg BVAL was cut one to five basis points: 2.80% (+5) in 2024 and 2.66% (+4) in 2025. The five-year at 2.33% (+3), the 10-year at 2.33% (+2) and the 30-year at 3.40% (+2) at 4 p.m.

Treasuries were weaker in most spots.

The two-year UST was yielding 4.088% (+15), the three-year was at 3.813% (+12), the five-year at 3.597% (+11), the seven-year at 3.568% (+10), the 10-year at 3.523% (+10), the 20-year at 3.880% (+6) and the 30-year Treasury was yielding 3.753% (+4) at 4 p.m.

GDP
The first look at “first quarter GDP showed the US economy grew at 1.1%, down from the prior quarter’s 2.6% reading and below the 1.9% consensus estimate,” said Edward Moya, senior market analyst at The Americas OANDA.

“It was a miss, but the whisper number was below 1.0%, so some traders viewed it as not such a bad number when you consider how strong the personal consumption figures were and overall resilience in the labor market,” he said.

“This is a print that surprised a bit to the downside on the headline GDP number, but the underlying resilience of the U.S. consumer was on full display,” said Olu Sonola, head of Fitch Ratings U.S. regional economics.

He noted that “spending on durable goods, particularly motor vehicle and parts, underpinned the solid growth in overall consumer spending,” but “residential investment was negative for the eighth consecutive quarter and business investment was relatively flat.”

“The bottom line is that overall momentum is slowing, but the strength of the consumer continues to exceed expectations,” Sonola said.

Monthly data suggests “that consumer spending has lost momentum over the past few months,” said Wells Fargo Securities chief economist Jay Bryson.

Moreover, he noted “consumers are relying increasingly on credit and stockpiled cash to finance their purchases.”

These factors are not sustainable, according to Bryson.

He forecasts “the U.S. economy to slip into recession, which he expects will be of moderate severity, in the second half of the year.” 

“The U.S. economy eked out modest growth in the first quarter on the back of strong consumer spending,” said Morning Consult chief economist John Leer.

However, he said, “the consumer ended the quarter on a sour note, calling into question the sustainability of economic growth moving forward.”

“While private investment may pick back up later this year, it tends to be highly volatile from quarter to quarter,” Leer said. “Without a robust consumer, we’re likely to see more volatility and uncertainty in economic activity through the end of the year.”

“There is something to grab onto for both the bulls and the bears in [Thursday’s] data release which showed slower growth, but a resilient labor market,” said Alexandra Wilson-Elizondo, co-head of portfolio management for Multi Asset Solutions at Goldman Sachs Asset Management.

On one hand, she said “the economy was growing below trend at an annualized rate of 1.1% in the first quarter, materially below the consensus estimate of 1.9%.” This data, though, “does not yet reflect the impact of the stress in the regional bank sector which will have a long tail,” Wilson-Elizondo said

But on the other hand, she said “the data supports a hawkish Fed to address the continued strength in the labor market and subsequent sticky inflation.”

Taken all together, Wilson-Elizondo said “the conflicting data signals to us that we are in the ‘bend, not break’ phase of the cycle.”

While the “underlying details of the Q1 GDP report were undeniably robust, high-frequency and monthly data suggest activity softened decidedly in March, lowering the starting point for Q2 and raising concerns for the outlook,” said Mickey Levy, chief economist for Americas and Asia at Berenberg Capital Markets.

Absent revisions to January and February, he said “real personal consumption likely declined 0.6% [month-over-month] in March, while forward-looking measures of production and manufacturing orders point to a deteriorating backdrop for business fixed investment and industrial production.”

Adding to the downside risks, Levy said “data through Q1 largely predate domestic banking turmoil that began in mid-March and do not reflect the full extent of tightening credit conditions and standards that will likely unfold over the coming months.”

“The strength of data in early Q1 was also likely boosted by weather and seasonal adjustment effects that will likely unwind over the course of Q2,” he said.

Unfortunately, “the sharp slowdown in economic growth last quarter was not sufficient to temper price inflation,” said Scott Anderson, chief economist at Bank of the West

The core PCE deflator “expanded at an annualized rate of 4.9% in the first quarter … above the consensus forecast of 4.7% and the fastest pace in a year,” he said.

“Despite weakening growth and the elevated probability of a mild U.S. recession on the horizon, we believe persistent core price inflation will prompt the Fed to raise interest rates by another quarter percentage point next month before an extended pause,” Anderson said.

Wilson-Elizondo also expects a 25 basis point rate hike in at the May Federal Open Market Committee meeting with a “hawkish hold” message from the Fed.

“This complicates both the ability to estimate the timeline to recession, and ultimately the breadth and depth of one,” Wilson-Elizondo said. “Further, it is hard to price the ultimate outcomes which is why we believe we are seeing conflicting messages from equities and fixed income.”

“Continuing growth in the economy, coupled with a strong job market and inflation that is still too high — the first quarter PCE index showed 4% growth, double the Fed’s target — will likely lead the Fed to raise the Fed Funds Rate one more time at its next meeting, even as credit conditions tighten due to challenges and uncertainty in the banking sector,” said Joel Kan, Mortgage Bankers Association vice president and deputy chief economist. “They are expected to then hold the funds rate at this higher level at least through the end of 2023.”

He forecasts “a short recession in the coming quarters, as these tighter financial conditions exert a drag on consumer and business activity through tighter lending conditions and higher rates.”

This, Kan said, “will cause the unemployment rate to rise and gradually lower inflation closer to the Fed’s 2% target by the end of 2024.”

Mutual fund details
Refinitiv Lipper reported $92.055 million of municipal bond mutual fund outflows for the week that ended Wednesday following $2.876 billion of outflows the previous week.

Exchange-traded muni funds reported inflows of $416.836 million after outflows of $629.981 million in the previous week. Ex-ETFs, muni funds saw outflows of $508.890 million after outflows of $2.246 billion in the prior week.

Long-term muni bond funds had outflows of $100.401 million in the latest week after outflows of $2.260 billion in the previous week. Intermediate-term funds had inflows of $196.536 million after outflows of $45.626 million in the prior week.

National funds had outflows of $41.766 million after outflows of $2.820 billion the previous week while high-yield muni funds reported outflows of $557.501 million after outflows of $79.125 million the week prior.