May 18, 2024

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Munis largely ignore moves in other markets post-FOMC, close out April in the red

7 min read
Munis largely ignore moves in other markets post-FOMC, close out April in the red

Municipals were little changed Wednesday as U.S. Treasury yields fell and equities rallied after the Federal Reserve held rates steady.

“There was a collective sigh of relief in the financial markets after the Fed refrained from increasing its hawkishness at the May FOMC meeting,” said Jack McIntyre, portfolio manager at Brandywine Global.

“In fact, nothing really has changed regarding the Fed’s tone. Powell said rates are currently restrictive enough, meaning a rate hike is highly unlikely. But he also cautioned that inflation is still too high to start cutting rates too soon.”

The two-year muni-to-Treasury ratio Wednesday was at 65%, the three-year at 64%, the five-year at 62%, the 10-year at 61% and the 30-year at 84%, according to Refinitiv Municipal Market Data’s 3 p.m. EST read. ICE Data Services had the two-year at 64%, the three-year at 62%, the five-year at 60%, the 10-year at 61% and the 30-year at 81% at 3:30 p.m.

The Investment Company Institute reported outflows from municipal bond mutual funds for the week ending April 24, with investors pulling $151 million from funds following $328 million of outflows the week prior. This differs from LSEG Lipper, which reported $200.3 million of inflows for the same timeframe.

ICI reported exchange-traded funds saw inflows of $776 million following $886 million of outflows the week prior.

Munis posted losses in April, returning negative 1.24%. The asset class is also seeing losses of 1.62% year-to-date.

The Muni High Yield Index returned negative 0.61%, but has seen positive returns of 0.89% year-to-date. Taxable munis were in the red 2.91% in April and 2.8% in the first four months of 2024.

U.S. Treasuries and corporates saw losses, returning negative 2.79% and negative 2.54% in April, respectively. USTs were in the red negative 5.6% year-to-date, while corporates were in the red negative 2.93%.

“The municipal bond market proved to be resilient emerging from this period of extremely elevated tax-exempt supply ($133 billion year-to-date volume was the highest since 2007’s $147 billion), low reinvestment capital (April’s $21 billion was the lowest of the year and lowest since April of 2020), as well as outflows leading into the April 15 U.S. tax deadline,” J.P. Morgan strategists. 

Issuance for April topped $40 billion, marking the fourth consecutive month of gains year-over-year.

While muni yields were steady Wednesday, yields across the muni AAA high-grade curve “hit new year-to-date highs last week, while the muni HG curve shows outperformance across the curve this month relative to the broader fixed income market,” J.P. Morgan strategists said.

Absolute yields look “attractive in the context of the trading range over the past three years and our longer-term projections for lower rates this year,” they said.

The two-year investment grade muni ratios “richened modestly versus taxable fixed-income this week, but remaining at transactional levels,” they said.

Ratios appear “progressively richer” near the five- to 10-years on the curve, “with the 10-year spot still far more attractive in taxables versus tax-exempts,” according to J.P. Morgan strategists.

The longest part of the tax-exempt market is where value is “most apparent … with ratios of 30-year AA tax-exempts closer to the middle of the trailing three-year range,” they said.

“Current valuations and expectations for technicals suggest continued less favorable technicals moving into May,” they said.

May’s redemptions flows will tick down 1% month-over-month, though “the flurry of [Build America Bond] refunding deals will result in actual redemptions ending up higher than April’s,” said Pat Luby, head of municipal strategy at CreditSights.

Eighteen issuers have been identified by J.P. Morgan strategists this year that have either called BABs, posted conditional notices or announced considerations, totaling $9.7 billion so far in 2024.

May will see $21.6 billion of principal returned, $3.2 billion of which will come from taxable munis, Luby said.

More than half of the $21.6 billion — $11.6 billion of principal — will be redeemed Wednesday, Luby said

Investors will also receive $11 billion of interest this month, $7 billion of which will be paid Wednesday, he noted.

“The reinvestment of called and matured bond principal is an important source of demand for the municipal bond market,” Luby said. “The seasonal waxing and waning of redemptions can add or subtract technical support for the market.”

While May’s payments are expected to be “slightly higher” month-over-month, the “heavy surge” of redemptions in June through August can potentially fuel demand, he said.

AAA scales
Refinitiv MMD’s scale was little changed: The one-year was at 3.42% (unch, -3bp May roll) and 3.22% (unch, no May roll) in two years. The five-year was at 2.85% (unch, no May roll), the 10-year at 2.82% (unch, +1bp May roll) and the 30-year at 3.96% (unch) at 3 p.m.

The ICE AAA yield curve was bumped one to two basis points: 3.41% (-1) in 2025 and 3.22% (-2) in 2026. The five-year was at 2.85% (-2), the 10-year was at 2.83% (-2) and the 30-year was at 3.89% (-2) at 3:30 p.m.

The S&P Global Market Intelligence municipal curve was unchanged: The one-year was at 3.46% in 2025 and 3.23% in 2026. The five-year was at 2.84%, the 10-year was at 2.84% and the 30-year yield was at 3.94%, according to a 3 p.m. read.

Bloomberg BVAL was little changed: 3.46% (unch) in 2025 and 3.26% (unch) in 2026. The five-year at 2.79% (unch), the 10-year at 2.78% (unch) and the 30-year at 3.95% (unch) at 3:30 p.m.

Treasuries were firmer.

The two-year UST was yielding 4.949% (-9), the three-year was at 4.796% (-8), the five-year at 4.644% (-8), the 10-year at 4.626% (-6), the 20-year at 4.855% (-5) and the 30-year at 4.745% (-5) at 3:30 p.m.

The Federal Open Market Committee held interest rates at a range between 5.25% and 5.50%, as expected, noting “a lack of further progress” in taming inflation.

The panel said it will reduce the monthly redemption cap on Treasury securities from $60 billion to $25 billion in June, while maintaining its monthly redemption cap on agency debt and agency mortgage‑backed securities at $35 billion.

Despite raising rates five percentage points in this cycle, the economy remains strong, said Erik Weisman, chief economist and fixed income portfolio manager at MFS Investment Management.

Explanations for this, he suggested, include: fundamental condition changes resulted in the economy becoming less sensitive to interest rates. “If that’s the case, the Fed may need to raise rates further,” Weisman said.

Another explanation could be “the economy is still rate sensitive, but effective real rates aren’t that high while broad financial conditions are still accommodative. If so, the Fed needs to gradually raise rates until monetary policy is sufficiently tight,” he said.

His final suggestion is the pandemic stimulus made the economy less rate sensitive, meaning the Fed will need to wait for the impact of the hikes.

“The bottom line is that the Fed is in an unenviable position of having to figure all of this out without much of a compass,” Weisman said.

“The statement explicitly recognizes the recent deterioration in inflation dynamics,” said Brian Coulton, Fitch Ratings chief economist. The three latest inflation and wage data reports were too high and the labor market remains strong, he noted, limiting the “risk to the Fed’s employment mandate from waiting longer before embarking on rate cuts.”

However, Coulton said, “the risk of failing to get inflation down on a sustained basis seems to be rising as each week goes by. Patience is the watchword now for the Fed and the risk of fewer or no rate cuts this year is growing.”

Economic data will allow the Fed to be patient before cutting rates, said Whitney Watson, co-chief investment officer and co-head of fixed income and liquidity solutions at Goldman Sachs Asset Management.

“We expect the downtrend in inflation has been delayed, not derailed,” Watson said. “As for the Fed’s balance sheet reduction today’s decision to taper quantitative tightening is a nod to liquidity considerations in the financial system, rather than a shift in direction.”

“Policy is restrictive and weighing on demand,” Federal Reserve Board Chair Jerome Powell said in response to a question during his press conference.

“It’s unlikely the next policy rate move will be a hike,” he said. “We’d need to see persuasive evidence that our policy stance is not sufficiently restrictive to bring inflation down to 2%” to consider a hike, and “we’re not seeing that.” He added that the Fed would not be satisfied if inflation remained at 3% and asserted that the FOMC would get inflation down to the target level.

Powell said inflation remains too high and he expects further progress on inflation this year, “I don’t know that it will be sufficient, I don’t know that it won’t” be enough to allow rate cuts.

Regarding the coming elections and monetary policy, Powell said, “We’re always going to do what we think the right thing for the economy is when we come to that consensus. We’re not looking at anything else.”

Negotiated calendar
The New Jersey Higher Education Student Assistance Authority is set to price Thursday $226.550 million of student loan revenue and refunding bonds, Series 2024, consisting of $24.8 million of Series A (/AA//), serials 2027-2033; $176 million of Series B (/AA//), serials 2027-2033, term 2045, and $25.75 million of Series C (/BBB//), serial 2054. RBC Capital Markets.

San Francisco (Aa1/AA+/AAA/) is set to price Thursday $218.56 million of tax-exempt Multiple Capital Improvement Projects refunding certificates of participation, Series 2024-R1. RBC Capital Markets.

The University of Massachusetts Building Authority (Aa2/AA-/AA-/) is set to sell $152.085 million of senior project revenue bonds, Series 2024-1, at 10:15 a.m. Thursday.

The Washoe County School District, Nevada, (Aa3/AA//) is set to sell $130 million of limited tax GO school improvement bonds, Series 2024A, at 11:30 a.m. Thursday.

The Nauset Regional School District, Massachusetts, is set to sell $120.5 million of unlimited tax GO school bonds, at 11 a.m. Thursday.

Gary Siegel contributed to this story.