Municipals were weaker Tuesday in choppy secondary trading while U.S. Treasuries and equities were mixed near the close.
Triple-A benchmarks were cut up to three points, depending on the scale, while UST yields rose on the short end and fell seven years and out.
Muni to UST ratios were at 83% in five years, 94% in 10 years and 103% in 30, according to Refinitiv MMD’s 3 p.m. read. ICE Data Services had the five at 81%, the 10 at 93% and the 30 at 104% at a 3:30 p.m. read.
In the primary market Tuesday, BofA Securities priced for the Michigan State Housing Development Authority (/AA//) $135.065 million of non-alternative minimum tax rental housing revenue bonds, 2022 Series A. All bonds are priced at par: 2.65s of 10/2024, 3.35s of 4/2027, 3.40s of 10/2027, 3.85s of 4/2032, 3.90s of 10/2032, 4.10s of 10/2037, 4.25s of 10/2042, 4.35s of 10/2047 and 4.45s of 10/2052, callable in 4/1/2032.
BofA Securities also priced for the Genesee County Funding Corp., New York, (/BBB+//) $129.095 million tax-exempt Rochester Regional Health Project revenue bonds, Series 2022A. Bonds in 12/2022 with a 5% coupon yield 2.68%, 5s of 2027 at 3.67%, 5s of 2032 at 4.16%, 5s of 2037 at 4.36%, 5s of 2041 at 4.42% and 5.25s of 2052 at 4.52%, callable 12/1/2032.
In the competitive market, the Broward County School District, Florida, (Aa2/AA-//) sold $262.730 million of general obligation school bonds, Series 2022, to BofA Securities. Bonds in 7/2023 with a 5% coupon yield 2.15%, 5s of 2027 at 2.80%, 5s of 2032 at 3.08%, 5s of 2037 at 3.33%, 5s of 2042 at 3.41%, 5s of 2047 at 3.55% and 5s of 2051 at 3.60%, callable 7/1/2032.
Seattle, Washington (Aaa/AAA/AAA/) sold $134.425 million of limited tax general obligation improvement and refunding bonds, Series 2022A, to BofA Securities. Bonds in 9/2022 with a 5% coupon yield 1.65%, 4s of 2027 at 2.54%, 5s of 2032 at 2.92%, 4s of 2037 at 3.33% and 5s of 2042 at 3.20%, callable in 9/1/2032.
The municipal market was marked by some skittishness among investors on Tuesday as a new month gets underway.
“Entering May, muni participants are extremely guarded after the indices posted negative returns for April with now heavier losses year-to-date,” said Jeffrey Lipton, managing director of municipal credit and research at Oppenheimer & Co.
“This week’s FOMC meeting adds more anxiety as Central Bank messaging is of critical importance,” he noted.
A 50 basis point rate hike in the funds rate is fully priced in, according to Lipton, who said “all eyes are now focused on subsequent policy sessions to see just how much tightening the Fed will apply to combat inflation.”
Munis, he said, now offer favorable relative value and investors should be seeking opportunistic situations that could offer an inflationary hedge.
Despite the roughness of April returns — and the related stress those create for customer statements and communications — “things were a bit better for bonds last week” said Matt Fabian, partner at Municipal Market Analytics.
He said munis continue to deal with mutual fund outflows, noting an estimated $3 billion loss last week, per the Investment Company Institute, which brings cumulative fund flows year-to-date to= $45.9 billion, nearing the $46 billion lost in six weeks in 2020.
“And that outflow pressure appears to have eventually used up more or most of the market’s available liquidity, orderly selling has become something worse,” Fabian said. Bids wanteds were at “a worrisome $10 billion last week.”
A return to strong/stable net creations to the tune of about $1 billion by the ETFs to start the month suggests some demand normalcy remains — or fund investors have not completely abandoned the asset class, he noted.
Dealer inventories remain thin versus prior investment, and Fabian said the industry likely has to begin thinking of this as a baseline for dealer carry “absent a change in market-making alternatives like electronic trading accounts.”
While the municipal market has had 15 weeks to “retrain investment strategies” around ex-ETF mutual funds losing assets on a weekly basis, he said “the impact of such goes beyond just the subtraction of some demand and the addition of some secondary supply.”
Before 2022, he said “the largest mutual funds were the key driver in municipal demand evolution and the reason that our primary market could continue to function at such low yields and tight spreads.”
But “absent a return of the funds, tax-exempt municipals will similarly be unable to return to prior levels” — or even evidence a solid rally that would threaten such a return, he said.
“The question remains, once fund assets do stabilize and/or begin to grow again, will the funds resume their prior momentum-driven buying behavior or will they instead look to benefit from the market’s current defensive, wider-spread orientation,” Fabian said.
The focus on the behavior of funds pre-2022 is important: One, because the big funds were able “to employ extreme single risk diversification to reduce their portfolios’ exposure to idiosyncratic credit risk, enabling time-saving shortcuts like automated credit approvals and surveillance and thus their participation in less-rated, more weakly secured and smaller-sized pieces of debt.”
And two, “the funds’ focus on momentum and total return so as to better compete against other asset classes on their principal distribution platforms encouraged, or even mandated, the participation in lower-coupon and lower-rated structures to outperform as yields fell and credit spreads tightened.”
North Carolina 5s of 2023 at 2.04%. Virginia Commonwealth Transportation Board 5s of 2024 at 2.29%-2.27%. New York City 5s of 2024 at 2.51%-2.52%. District of Columbia 5s of 2026 at 2.55%-2.56%. Maryland 5s of 2026 at 2.46%-2.45%.
Washington 5s of 2029 at 2.77%-2.75% versus 2.73% original (on 4/27). Georgia 5s of 2029 at 2.65% versus 2.67% on 5/2 and 2.59%-2.58% on 4/25. Massachusetts 5s of 2029 at 2.75%.
NYC Municipal Water Finance Authority 5s of 2035 at 3.29% versus 3.27%-3.28% on 4/22.
NYC TFA 5s of 2041 at 3.68%-3.66% versus 3.56%-3.55% on 5/2 and 3.30% on 4/14. NY Dorm PIT 5s of 2041 at 3.70%-3.69%.
NYC TFA 5s of 2047 at 3.81%-3.79% versus 3.60% on 4/20 and 3.57%-3.60% on 4/19.
Refinitiv MMD’s scale was cut up to two basis points at the 3 p.m. read: the one-year at 1.97% (unch) and 2.25% (+2) in two years. The five-year at 2.51% (+2), the 10-year at 2.78% (+2) and the 30-year at 3.11% (+2).
The ICE municipal yield curve was cut one to two basis points: 2.00% (+1) in 2023 and 2.31% (+1) in 2024. The five-year at 2.47% (+1), the 10-year was at 2.75% (+2) and the 30-year yield was at 3.16% (+1) at a 3:30 p.m. read.
The IHS Markit municipal curve was cut two to three basis points five years and out: 1.99% in 2023 (unch) and 2.24% (unch) in 2024. The five-year at 2.49% (+3), the 10-year was at 2.75% (+3) and the 30-year yield was at 3.10% (+2) at 3 p.m.
Bloomberg BVAL was cut up to one basis points: 1.96% (+1) in 2023 and 2.22% (unch) in 2024. The five-year at 2.51% (+1), the 10-year at 2.74% (+1) and the 30-year at 3.05% (+1) at a 3:30 p.m. read.
Treasury yields were mixed.
The two-year UST was yielding 2.771% (+4), the three-year was at 2.952% (+1), five-year at 3.009% (flat), the seven-year 3.034% (flat), the 10-year yielding 2.967% (-2), the 20-year at 3.224% (-2) and the 30-year Treasury was yielding 3.018% (-2) at a 3:30 p.m. read.
What FOMC means for bonds
The Federal Reserve has become quite transparent and there is consensus that the Federal Open Market Committee meeting that began Tuesday morning will end with a half-point rate hike and information about balance-sheet reduction.
But the Fed’s use of forward guidance allowed the bond market a head start on pricing in “much of this tightening cycle,” said John Hancock Investment Management Co-Chief Investment Strategist Emily Roland. She pointed to the two-year Treasury, where the yield had jumped 1.82% through April 26, and the 10-year’s 1.26% gain.
The fed funds futures pricing in about 250 basis points of increases in 2022, she noted. “Because aggressive tightening is already reflected in bond yields, an investor who is betting against bonds from here (expecting yields to go up) is essentially betting that there will be more than 10 rate hikes this year,” Roland said. “In our view, this is unlikely given the slowdown in economic growth we’ve been highlighting.”
Still, the panel “is in a tough spot right now,” said Morning Consult Chief Economist John Leer, “as it navigates elevated risks of a recession. They want to raise rates high enough and fast enough to curb inflation, but they don’t want to tip the economy into a recession.”
While the markets have already priced in a 50-basis-point hike, he said, the April employment report, due Friday and next week’s consumer price index could move the markets. “A serious miss on either front exposes markets to further corrections, which in turn could weigh on the real economy.”
Given the forward guidance that has tightened financial conditions, Mark Dowding, chief investment officer at BlueBay Asset Management, said, “this suggests to us that the FOMC does not need to overplay a hawkish message.”
While he sees a 50-basis-point increase at this meeting and again in June, “thereafter, the course of policy may become less certain with inflation slowing and risks to growth building on the downside.”
Next year, a recession is possible, Dowding said, but “ultimately, a recession becomes more likely if the Fed needs to keep hiking beyond a perceived assessment of where the neutral rate sits, which policymakers estimate is around 2.5%. In turn, this will hinge on the trajectory for inflation.”
As for inflation, he said, “there are good reasons to believe that price rises will be back below 4% by the end of this year and on a declining trend.” If that comes to fruition, the Fed could “take a more measured approach to rates later in the year after a more assertive stance in the next few months, as pressure on the Fed to act starts to abate.”
Don’t expect a recession, maybe a “soft patch,” said DWS head of fixed income Greg Staples. Although some analysts see “a recession in 2023, it remains unlikely that market observers will see two consecutive quarters of negative growth,” he said. “However, they could still see a quarter or two of 1% growth or zero percent growth or even slightly negative, but two consecutive quarters of negative growth is unlikely.”
“Unintended consequences” concern Grant Thornton Chief Economist Diane Swonk. “The Fed wants to tighten credit conditions, not trigger a seizure in credit markets.” But the panel is “behind the curve on inflation and ready to move aggressively.”
She expects Fed Chairman Jay Powell to be peppered with questions about bringing inflation down without triggering a recession. “Many within the Fed have voiced their skepticism about achieving a soft landing at this late stage of the game,” she said.
The chair, Swonk noted, “has said the landing could be ‘soft-ish’ instead of ‘soft’.” She interprets “soft-ish” as encompassing rising unemployment “that is essentially like a mild recession, even if growth does not slip into negative territory for the obligatory two consecutive quarters.”
And while the Fed could use rate hike alone to squash inflation, Swonk said, “that would raise other questions about symmetry. If the balance sheet helped ease credit conditions, it should be reduced to tighten credit conditions. That sounds good on paper but there is no road map for doing this.”
Indeed, Tim Drayson, chief U.S. economist for Legal & General Investment Management (LGIM), noted, “The ultimate size of the balance sheet is yet to be determined, but it will likely take at least three years to get there, and the Fed intends to stop the shrinking well before excess reserves become scarce.”
That should avert “the mistakes of late 2018 and into 2019,” he said. “In theory, quantitative tightening (QT) should have relatively little impact on markets,” since they have time to prepare for its implementation.”
Also, Drayson noted, the markets reacted not to the excess reserves accumulation, but rather to “the commitment to low interest rates which QE signaled.”
Still, “if enough market participants believe in the nebulous concept of liquidity withdrawal,” he said, “it can have real effects. Especially if QT coincides with rate rises, an increasing term premium due to longer term inflation uncertainty and the likely squeeze in corporate margins and a profits recession in the quarters ahead as growth and inflation slow but labor cost growth remains strong due to the tight labor market.”
Primary to come:
The Triborough Bridge and Tunnel Authority (/AA+/AA+/AA+) is set to price Thursday $945.3 million of payroll mobility tax senior lien refunding bonds, Series 2022C, serials 2040-2044, terms 2047, 2052 and 2057. Siebert Williams Shank & Co.
Presbyterian Healthcare Services, New Mexico, (Aa3/AA/AA/) is set to price Thursday $341 million of taxable corporate CUSIP bonds, Series 2022. J.P. Morgan Securities.
North Carolina (Aa1/AA+/AA+/) is set to price Thursday $300 million of Build NC limited obligation bonds, Series 2022A, serials 2023-2037. Wells Fargo Bank.
Santa Clara County, California, is set to sell $237.995 million of Election of 2008 general obligation bonds, 2022 Refunding Series D (dedicated unlimited ad valorem tax bonds) at 11 a.m. eastern Thursday.