Municipals were little changed Wednesday, being cut a basis point or two in spots to close out August, while U.S. Treasuries sold off ten years and out and equities ended in the red.
“The tone heading into month end remains mostly unchanged from the post-rate hike/post-Jackson Hole dialogue, with conflicting metrics holding back more momentum as the market wraps up two-thirds of the year,” said Kim Olsan, senior vice president of municipal bond trading at FHN Financial.
The short and long ends of the curve “have undergone the most yield changes this year,” she said.
Short-term rates have risen 173 basis points since the start of the year, “impacted by a ratio correction to align with USTs reacting to rate hikes,” while intermediate muni yields are up about 150 basis points, “buffered in part by more defined flows. Long-dated munis, she said, “have yet to fully recover from heavy selling during the second quarter, leaving the 30-year spot higher by 180 basis points from the end of December.”
“Absolute yields hold a much greater value proposition on the back half of the curve, given a variety of coupon alternatives, as well,” Olsan said.
Cross-market values, she said, “have risen substantially as the effect of heavy fund reallocations has weighed on ratios.”
Short muni-UST ratios fell below 50% at the end of September and the 10-year triple-A MMD spot traded through 70% to the 10-year UST. “A steeper curve was an incentive during most of 2021, holding the 30-year AAA ratio to below 80% by the end of the year,” she said.
Olsan added “active bid list volume for most of this year has moved relative value into more historical (and even wider) ranges.”
On Wednesday, the two- and three-year muni-UST ratios are around 66% to 67%. The five-year was at 71%, the 10-year at 83% and the 30-year at 102%, according to Refinitiv MMD’s 3 p.m. read. ICE Data Services had the five at 71%, the 10 at 88% and the 30 at 102% at a 4 p.m. read.
“Ratios on the short end of the curve — which were extremely overvalued just a couple of weeks ago — continue to get cheaper and are finally at about their one-year average,” said Roberto Roffo, managing director and portfolio manager at SWBC Investment Services LLC.
In addition, he noted, 30-year ratios continue to offer the best value at approximately 100% of Treasuries, and “if the economy does eventually go into a prolonged recession, offer the best return potential,” he said.
“Ratios of 70% or greater along the entire curve should be an additional draw for new inquiry as the calendar grows during September,” Olsan said.
”A large component to rate direction this year has been the weekly outflow figure,” she said.
The Investment Company Institute reported $755 million of outflows from muni bond mutual funds in the week ending August 24 compared to $320 million of inflows the previous week.
Exchange-traded funds saw outflows of $337 million versus $200 million of outflows the week prior, per ICI data.
The average flow figure in 2021 was a positive $1.6 billion as “buyers made substantial allocations into tax-exempt strategies,” but “the rate backup that began in February and continued in force through June pushed buyers out of funds on asset losses — resulting in a weekly flow average of negative $2.6 billion,” according to Olsan.
“An irony to such heaving selling exacerbating the outflows is much higher entry points in quality-rated bonds,” she said. “New York City GO 4s due 2042 issued in August 2021 at 1.90% are now trading at 4.20%.”
In the primary, Citigroup Global Markets priced for the New Jersey Housing and Mortgage Finance Agency (Aa2/AA//) $315.730 million of non-AMT social single-family housing revenue bonds, 2022 Series I, with 2.35s of 10/2023 at par, 3.1s of 4/2027 at par, 3.15s of 10/2027 at par, 3.85s of 4/2032 at par, 3.9s of 10/2032 at par, 4.25s of 10/2037 at par, 4.5s of 10/2042 at par, 4.6s of 10/2046 at par and 5s of 10/2053 at 3.80%, callable 4/1/2031.
New-issue volume this week in the primary is slightly below the yearly average and should clear the market due to cash on hand and the current ratios, according to Roffo.
Primary volume is being absorbed — even if it’s taking a bit longer than usual due to overall market turmoil, according to Tom Kozlik, head of municipal research and analytics at HilltopSecurities Inc.
“Issuers are hopeful that interest rate and Fed uncertainty will abate so a more predictable market — and market demand — returns,” Kozlik said.
A key driver of market activity, he said, remains the potential path the Federal Reserve is likely to take — not only for the remainder of 2022 but also in 2023.
“I think the word ‘hopeful’ sums up views from many market participants to end the ‘summer many would like to forget,'” Kozlik added.
Secondary trading
New York City TFA 5s of 2023 at 2.25%-2.24%. Georgia 5s of 2023 at 2.25%-2.22%. Maryland 4s of 2023 at 2.24% versus 2.23% Monday. Maryland 5s of 2024 at 2.35%-2.32%. District of Columbia 5s of 2024 at 2.34%.
Washington 5s of 2027 at 2.42%. NYC TFA 5s of 2028 at 2.59%. California 5s of 2030 at 2.55% versus 2.59% Tuesday. Montgomery County, Maryland, 5s of 2032 at 2.67%-2.66% versus 2.56% on 8/22 and 2.49% original on 8/18.
NYC 5s of 2036 at 3.58%-3.59% versus 3.17% on 8/10. NYC 5s of 2038 at 3.60% versus 3.57% Monday and 3.50% original on 8/18.
Washington 5s of 2046 at 3.69% versus 3.64%-3.63% Friday and 3.47%-3.48% on 8/23.
AAA scales
Refinitiv MMD’s scale was cut up to two basis points on the short end at the 3 p.m. read: the one-year at 2.21% (+2) and 2.28% (+2) in two years. The five-year at 2.32% (unch), the 10-year at 2.59% (unch) and the 30-year at 3.29% (unch).
The ICE AAA yield curve was cut one to three basis points: 2.28% (+3) in 2023 and 2.33% (+2) in 2024. The five-year at 2.36% (+1), the 10-year was at 2.70% (+1) and the 30-year yield was at 3.31% (+1) at a 4 p.m. read.
The IHS Markit municipal curve was cut two basis points at the one- and two-years: 2.21% (+2) in 2023 and 2.29% (+2) in 2024. The five-year was at 2.31% (unch), the 10-year was at 2.60% (unch) and the 30-year yield was at 3.28% (unch) at a 3 p.m. read.
Bloomberg BVAL was cut up to one basis point: 2.26% (unch) in 2023 and 2.28% (+1) in 2024. The five-year at 2.29% (unch), the 10-year at 2.59% (+1) and the 30-year at 3.29% (+1) at 4 p.m.
Treasuries were weaker.
The two-year UST was yielding 3.468% (+2), the three-year was at 3.480% (+2), the five-year at 3.317% (+5), the seven-year 3.280% (+7), the 10-year yielding 3.169% (+7), the 20-year at 3.553% (+6) and the 30-year Treasury was yielding 3.285% (+7) at 4 p.m.
Economy
Federal Reserve Board Chair Jerome Powell was correct that the central bank has more work to do, analysts said.
It’s not “mission accomplished” for the Fed, said Jeff Klingelhofer, co-head of investments and managing director at Thornburg Investment Management. Rates will continue to go up.
“For me, what’s perhaps most important is that inflation expectations themselves have stayed within a relatively contained band for some time and only now have begun to edge lower,” he said. Still, “hiring freezes and layoffs are ratcheting up across industries,” suggesting “a not so peaceful coexistence” between price stability and full employment.
And despite two quarters of negative GDP, Klingelhofer said, “the world today doesn’t feel like it’s in a recession. But are we moving towards one? Probably.”
While the worst of the inflation numbers are in the past, rates will fall slowly, he said. “We expect the Fed to hike rates above neutral in September. This means that the Fed will shift from a neutral monetary policy to a restrictive monetary policy, which significantly raises the likelihood of a recession.”
Thornburg sees municipal bonds as “a bright spot for investors,” Klingelhofer said. “They look undervalued today versus taxable fixed income broadly. The underlying issuers and municipals remain very well capitalized, and we believe defaults are likely to stay low well into the future.”
Looking at Powell’s speech last week, Stifel Chief Economist Lindsey Piegza said “while much of Powell’s message was focused on convincing the market that the Committee is in it for the long haul, the size of future rate hikes remains unclear. The broader message was a steady climb higher, however incoming data will dictate the pace and magnitude of the September increase as well as future rate hikes.”
August inflation data, she said, will be key to the September rate decision. If inflation slows again, “at least some Fed officials will likely be comfortable with a lesser 50 bps hike while maintaining a focus on a long-term pathway above neutral.”
John Vail, chief global strategist at Nikko Asset Management, expects a half-point increase in September “with hawkish rhetoric about future hikes” followed by similar 50-basis-point hikes “every meeting until March when we expect them to shift to 25 bps hikes.”
The markets, noted David Kelly, chief global strategist at JPMorgan Asset Management, expect the fed funds rate — now 2.25%-2.50% — to end the year between 3.50% and 3.75%, with another 25 basis points added early next year and two 25-basis-point cuts later in 2023 “although the futures market was pricing slightly less confidence in two rate cuts in late 2023 following Powell’s tough language.”
But the August consumer price index, if “mild,” may lessen “the market odds on aggressive Fed action, although we could still go into the September 21st meeting with the market betting on 75 basis points in tightening,” he said.
Since the Fed may ”feel some remorse for letting inflation get out of hand,” Kelly said, it “appears determined to sound and act tough on inflation.” Therefore, leaving doubt about the September hike could be “the easiest path,” so a 75-basis-point move “bolster[s] their hawkish credentials.”
Such a hike would allow a half-point raise in November and a quarter-point hike in December, he added, which “would take us to 3.75% to 4.00% by the end of this year.”
Still, Kelly noted, “it is a very close call on recession. … One more shock and we would be in recession.”
Investors should expect “the potential for volatility in the short run.”
Joseph Kalish, chief global macro strategist at Ned Davis Research, takes issue with Powell “taking ownership of inflation.” While price stability is the Fed’s job, “Powell went further,” he said.
“Unfortunately, by taking ownership of inflation, Powell has made the Fed a potential scapegoat, and allowed our dysfunctional political system an out from enacting additional policies to relieve supply side shortages (recent legislation notwithstanding),” Kalish said.
If supply-chain issues aren’t solved politically, intermediate-term inflation will be a problem, he said. “If we don’t fix the supply problems with respect to energy, food, shelter, labor, and other commodities when demand is slowing, we could quickly find ourselves right back where we started once demand returns.”
If that happens, it will mean more rate hikes. “The risk is that at some point the public sees the Fed can’t do anything about the supply side, inflation expectations go up and rates remain high,” Kalish added. “In that environment financial assets struggle.”
Primary on Wednesday:
J.P. Morgan Securities priced for the Chicago O’Hare International Airport (/A+/A+/A+/) $1.768 billion of general airport senior lien revenue and revenue refunding bonds.
The first tranche, $1.109 billion of AMT revenue bonds, Series 2022A, saw 5s of 1/2025 at 3.04%, 5s of 2028 at 3.30%, 5s of 2031 at 3.69%, 5s of 2042 at 4.44%, 4.5s of 2048 at 4.79% (callable 1/1/2031), 5s of 2048 at 4.62%, 4.625s of 2053 at 4.83% (callable 1/1/2031), 5.25s of 2053 at 4.63% (callable 1/1/2031), 5.5s of 2053 at 4.54% (callable 1/1/2031) and 5.5s of 2055 at 4.64%, callable 1/1/2032.
The second tranche, $150.860 million of non-AMT revenue bonds, Series 2022B, saw 4.5s of 1/2056 at 4.69% and 5.25s of 2056 at 4.26%. callable 1/1/2031.
The third tranche, $164.515 million of AMT revenue refunding bonds, Series 2022C, saw 5s of 1/2023 at 2.79%, 5s of 2027 at 3.29%, 5s of 2032 at 3.77%, 5s of 2037 at 4.23%, 5s of 2042 at 4.44% and 5s of 2044 at 4.53%, callable 1/1/2032.
The fourth tranche, $343.245 million of non-AMT revenue refunding bonds, Series 2022D, saw 5s of 1/2023 at 2.34%, 5s of 2027 at 2.62%, 5s of 2032 at 3.02%, 5s of 2037 at 3.58%, 4s of 2042 at 4.30% and 4s of 2044 at 4.38%, callable 1/1/2032.
Gary Siegel contributed to this report.