Muni curve flattens, UST steepens and inflows tick up

Municipals were stronger Thursday out longer, while U.S. Treasuries rallied, larger on the shorter end, and Refinitiv Lipper reported $600 million of inflows, the most since mid-September, signaling the fund complex is still engaged in the asset class.

Triple-A benchmarks bumped levels by one to three basis points, with the largest moves out longer on the curve with no changes on bonds inside six years, following on the one to three basis points yields fall on Wednesday, flattening the yield curve further.

Munis largely underperformed the curve steepening in UST, which saw levels fall nine basis points on the five- and 10-year and seven on the 20- and 30-year, pushing both below 2%.

The day’s moves saw municipal-to-UST ratios rise as a result. ICE Data Services had the 5-year muni-to-UST ratio at 55%, the 10-year at 76% and the 30 at 84% at the close. Refinitiv MMD’s 3 p.m. Eastern read had the 5-year municipal-to-UST ratio at 58%, the 10-year at 77% and the 30-year at 84%.

Secondary trading was on the lighter side and down 22% from Wednesday, but there was two-way flow and clear moves to lower yields on high-grade names and recently issued bonds, particularly outside of nine years.

For 35 weeks in a row, investors put cash into municipal bond funds as Refinitiv Lipper reported $603 million in the latest period while high-yield funds eked out a gain of slightly more than $1 million.

The primary on Thursday was active after a FOMC-muted session Wednesday.

BofA Securities priced for the Los Angeles Department of Water and Power (Aa2//AA-/AA) $399.375 million of power system revenue bonds, tight to triple-A benchmarks.

Bonds in 7/2026 with 5% coupon yield 0.63% and 3s and 4s of 2026 also 0.63%, all callable in 6/1/2026. Bonds in 2031 with a 5% coupon yield 1.18%, 5s of 2036 at 1.42%, 5s of 2041 at 1.58%, 5s of 2046 at 1.65% and 5s of 2051 at 1.75%, callable in 7/1/2031.

A 30-year LA DWP inter-dealer trade cleared at 1.72% in the secondary, indicative of dealer sentiment for the larger bumps out long.

J.P. Morgan Securities priced $303.031 million of corporate CUSIP taxable bonds for the Allina Health System (Aa3/AA-/AA-//). Bonds mature in 11/2051 to yield 2.902% par, callable in 5/15/2051.

Dallas, Texas (///AA+) sold $235.245 million of unlimited tax general obligation bonds to Morgan Stanley & Co. LLC. Bonds in 2/2023 with a 5% coupon yield 0.25%, 5s of 2026 at 0.63%, 5s of 2031 at 1.30%, 3s of 2036 at 1.86%, 3s of 2041 at 2.06% and 2.25s of 2042 at 2.34%, callable in 2/15/2031.

Barclays Capital priced for the Economic Development Authority of Lynchburg, Virginia, (Baa1/A-/A-/) $217.55 million of hospital revenue and refunding bonds (Centra Health Obligated Group). Bonds in 1/2027 with a 4% coupon yield 0.94%, 5s of 2031 at 1.52%, 5s of 2036 at 1.81%, 4s of 2041 at 2.14%, 4s of 2047 at 2.27%, 3s of 2051 at 2.55%, and 4s of 2055 at 2.37%, callable in 1/1/2032.

J.P. Morgan Securities priced for Minneapolis, Minnesota, (Aa3/AA-/AA-//) $167.77 million of exempt health care system revenue bonds (Allina Health System): 4s of 11/2036 at 1.76% and 4s fo 2040 at 1.86%, callable in 11/15/2031.

Attention will turn to the employment report Friday and a more robust calendar with bellwether credits that is building. Thirty-day visible supply climbed to $15.56 billion. A refocus on new slightly lower yields and higher ratios may position investors to be more selective in the coming week after supply this week was lacking in high-grade names.

The competitive calendar includes California, Wisconsin, Florida and Minnesota credits while the District of Columbia headlines the negotiated space.

Secondary trading
New York Urban Development Corp. 5s of 2022 at 0.12%. King County, Washington 5s of 2022 at 0.17%. Washington 5s of 2022 at 0.11%. Georgia 5s of 2023 at 0.26%.

Georgia 5s of 2024 at 0.29%-0.26% versus 0.31% Tuesday. Louisiana 5s of 2024 at 0.36%.

Monmouth County, New Jersey 5s of 2026 at 0.59%.

New York City 5s of 2029 at 1.13%. Maryland 5s of 2030 at 1.09%, 10 basis points lower than 10/27. California 5s of 2030 at 1.19%-1.18% versus 1.21% Friday. Montgomery County 5s of 2030 at 1.12%-1.11% versus 1.16%-1.15% Tuesday. Maryland 5s of 2031 at 1.16% versus 1.22%-1.20% Tuesday.

New York City TFA 5s of 2032 at 1.35% versus 1.45%-1.38% Wednesday. Maryland 5s of 2033 at 1.21% versus 1.28% Tuesday and 1.31% a week ago.

Hennepin 5s of 2034 at 1.26%-1.23%. Texas waters 5s of 2034 at 1.33% versus 1.40% Tuesday. Ohio waters 5s of 2034 at 1.31% versus 1.51% on 10/26. Cincinnati 5s of 2035 at 1.38%-1.37%.

Triborough Bridge & Tunnel 5s of 2038 at 1.65%-1.64%. Washington 5s of 2038 at 1.50%-1.49%, the same as Wednesday.

Iowa Finance Authority green bonds 5s of 2040 at 1.50%. Ohio 5s of 2040 at 1.54% versus 1.61% Tuesday. California 5s of 2041 at 1.54% versus 1.61%-1.60% Wednesday. Washington 5s of 2042 at 1.64%, a basis point lower than Wednesday.

Georgia road and tollway 4s of 2046 at 1.78%. New York Dorm NYU 5s of 2051 at 1.86% versus 1.98%-1.95% a week ago. Los Angeles Department of Water and Power 5s of 2051 at 1.72% versus 1.77% Wednesday and 1.80% Tuesday.

AAA scales
According to Refinitiv MMD, yields were steady on the short end with the one-year at 0.16% in 2022 and at 0.25% in 2023, the 10-year fell two to 1.17% and the yield on the 30-year fell two to 1.64%.

The ICE municipal yield curve showed bonds steady at 0.17% in 2022 and 0.25% in 2023. The 10-year maturity fell two to 1.14% and the 30-year yield fell three to 1.64%.

The IHS Markit municipal analytics curve showed short yields steady at 0.16% in 2022 and at 0.23% in 2023. The 10-year yield fell two to 1.16% and the 30-year yield down two to 1.65%.

The Bloomberg BVAL curve showed short yields steady at 0.17% in 2022 and at 0.21% in 2023. The 10-year yield fell two basis points to 1.16% and the 30-year was down three to 1.65%.

Treasuries were stronger and equities were mixed at the close.

The 5-year Treasury was yielding 1.110%, 10-year Treasury was yielding 1.520%, the 20-year at 1.962% and the 30-year Treasury was yielding 1.959%. The Dow Jones Industrial Average lost 80 points, or 0.20%, the S&P was up 0.30% while the Nasdaq gained 0.75%.

Refinitiv Lipper reports $603M inflow
In the week ended Nov. 3, weekly reporting tax-exempt mutual funds saw $602.933 million of inflows, Refinitiv Lipper said Thursday. It followed an inflow of $396.900 million in the previous week.

Exchange-traded muni funds reported inflows of $519.543 million, after inflows of $69.869 million in the previous week. Ex-ETFs, muni funds saw inflows of $83.390 million after inflows of $327.031 million in the prior week.

The four-week moving average remained positive at $409.586 million, after being in the green at $268.070 million in the previous week.

Long-term muni bond funds had inflows of $586.687 million in the latest week after inflows of $206.890 million in the previous week. Intermediate-term funds had inflows of $184.412 million after inflows of $171.580 million in the prior week.

National funds had inflows of $598.065 million after inflows of $396.609 million while high-yield muni funds reported inflows of $1.072 million in the latest week, after inflows of $3.232 million the previous week.

What will taper mean?
With the Fed giving itself flexibility about speeding up taper, it signaled a “split” within the panel, said Diane Swonk, chief economist at Grant Thornton. “The Federal Reserve has been growing more divided over the course of the summer and into the fall,” she said. “Chairman Powell would prefer to wait out inflation longer than many of his colleagues.”

The Fed will need to hasten the tapering early next year, she predicted. “This will open the door to sooner and more aggressive rate hikes.”

Her expectation is three rate hikes in 2022.

“The Fed is likely behind the curve and will have to move to a more hawkish stance and flag a pace a sooner and faster pace of rate hikes than it does currently,” said Sebastien Galy, senior macro strategist at Nordea Asset Management.

The Fed’s statement that it could alter the taper schedule creates “greater uncertainty about the path of monetary policy ahead,” said DWS Group U.S. Economist Christian Scherrmann. The pace of taper will provide “implicit guidance” about liftoff, with the second half of next year the current target.

Powell was masterful “threading a needle” in his press conference, said Jason England, global bonds portfolio manager at Janus Henderson Investors. He was “not leaning either dovish or hawkish.”

Marvin Loh, State Street global macro strategist, agreed. The chair showed a “willingness to act if inflation proves structural, but stat[ed] the Fed’s mandate required that it remain patient until reaching full employment.”

And while unemployment should drop as the virus comes under control, “the ultimate composition of the jobs market remains uncertain as the participation rate remains near 40 year lows,” he said. “While its dual mandate would require that it remain on the sidelines until that employment gap is closed, it may be forced to address persistent inflation that does not prove transitory.”

But ultimately, Loh said, without “hard metrics” on the Fed’s thinking about too high inflation levels or full employment, “we are left guessing when it will start the tightening process.”

If employment gains match those of the summer, liftoff in the last half of 2022 “will become a possibility,” he said, “particularly if inflation remains elevated.”

But “spotty jobs reports, with signs of transitory inflation,” would push off the initial rate hike.

“It is the uncomfortable position of slow job gains and continued elevated inflation prints that will create uncertainty,” Loh said. “Powell did however define transitory inflation as not having permanently higher prices, which the market continues to agree as transitory.”

The “tightrope walk” in the statement “signaled to me that the Fed lacks confidence in their ability to even forecast these apparent transitory factors,” said Lon Erickson, portfolio manager at Thornburg Investment Management. The “statement contained no signs of improvement to their forecasts and was packed with hedges so large a semi-truck could drive right through.”

Yet, the Fed maintains credibility and leeway, he said. And while the Fed didn’t set parameters for maximum employment or “what level of inflation is problematic,” Erickson said, “I believe the greater looming uncertainty is about how the Fed will make decisions, not any lack of movement.”

Moving slowly, given higher inflation and slower employment gains, is the only chance Fed has of “succeeding at the high wire balancing act.”

The level of inflation combined with economic strength suggest the Fed should be tapering more quickly, said Mickey Levy, Berenberg’s chief economist for the U.S., Americas and Asia, and a member of the Shadow Open Market Committee. “Remember, interest rates are zero, deeply negative in real terms and far below the Fed’s current estimate of the natural rate of interest at 2.5%.”

Despite no evidence of a wage-price spiral, “we do see higher inflationary expectations already influencing wage and price setting behavior in a re-enforcing pattern and worry that monetary and fiscal policies affect economic activity with a lag,” Levy said.

The Fed being more worried about employment than inflation most of this year, he said, contributed to higher inflation expectations. “We hope the Fed is right but worry that its monetary policies are not tilted toward the risks.”

Levy sees three rate hikes next year, in June, September and December.

Some analysts addressed Powell’s renomination, or the selection of another chair for the Fed. Thornburg’s Erikson said, “I think Powell loses his job in a game of political chess.” While keeping Powell insures “policy continuity,” he said, “I think Biden will have to sacrifice him to placate the progressives now that key parts of their agenda have been struck from proposed legislation.”

The fact that Powell has not yet been renominated “is fascinating,” said Edward Moya, senior market analyst for the Americas at OANDA. “The longer it takes Democrats to pass Biden’s infrastructure spending and economic package, the more nervous financial markets should become with Fed Chair Powell getting renominated.”

Tuesday’s elections, Moya added, “sent a message to the Biden administration and he is running out of things to offer progressives.” Replacing Powell might “appease Sen. Elizabeth Warren and other progressives.”

Thursday’s data showed initial jobless claims at a new pandemic low, the trade deficit growing, productivity off and labor costs rising.

Claims fell to a seasonally adjusted 269,000 in the week ended Oct. 30 from 283,000 a week earlier, while continuing claims fell to 2.105 million in the week ended Oct. 23 from 2.239 million a week earlier. Both were lower than projected.

Third quarter productivity fell 5.0% after a 2.1% gain in the second quarter while unit labor costs shot up 8.3% in the quarter after a 1.1% increase in the second. Economists polled by IFR Markets expected a 2.5% drop in productivity and a 5.8% jump in unit labor costs.

The productivity drop “says more about the temporary divergence in growth and employment trends over the quarter than about the outlook going forward,” said Wells Fargo Securities Senior Economist Sarah House.

“While the typical cyclical boost to productivity is behind us, we expect Q3 to be the low point for the cycle and the trend to strengthen ahead on the back of the impressive investment cycle to date. In the near-term, however, rising unit labor costs are expected to keep the heat turned up on inflation.”

The international trade deficit soared to $80.9 billion in September from a downwardly revised $72.8 billion in august, first reported as $73.3 billion.

Economists expected an $80.3 billion shortfall.

Chip Barnett contributed to this report.