Municipals were stronger and inflows returned Thursday, following a rally in U.S. Treasuries after GDP numbers came in weaker for the second month in a row and a day after the Fed hiked rates 75 basis points. Equities ended in the black.
Triple-A municipal yields fell up to eight basis points, depending on the scale, with the biggest moves in the belly of the curve, while UST yields fell 11 to 14 basis points, the best performance 10 years and in, as recession fears continued to spook investors.
Muni-UST ratios on Thursday were at 66% in five years, 83% in 10 years and 96% in 30 years, according to Refinitiv MMD’s 3 p.m. read. ICE Data Services had the five at 66%, the 10 at 88% and the 30 at 95% at a 3:30 p.m. read.
“Bond markets are jittery and highly sensitive to the Fed’s inflation versus growth dilemma,” said Andy Sparks, head of portfolio management research at MSCI.
He said that “market-implied inflation expectations have moved significantly lower based on remarks from the Fed and perceptions about how aggressive the Fed will be in combating inflation.”
Similarly, he noted, the recent flattening of the UST yield curve may suggest that “the market thinks the economy is weakening and that the Fed may need to begin lowering rates as early as 2023.”
Market participants, though, are waiting for a pause from the Fed in late 2022 or early 2023, said Gavin Stephens, director of portfolio management at Goelzer Investment Management.
“That appears to be premature — meaning that, while most of the damage is to bond returns is finished, the near-term path for rates should be higher,” he said.
But as the post-Fed meeting period begins, munis “are set to return to more typical proceedings,” said Kim Olsan, senior vice president of municipal bond trading at FHN Financial.
“August’s business will begin with a full calendar totaling more than $6 billion by early estimates and the first cycle of redemptions will be paid to holders (about $27 billion),” she said.
“Some of the questions related to immediate FOMC intentions were addressed, but the larger issue of economic strength (read: inflationary pressures) will be key to how various asset classes interpret near-term direction,” Olsan noted.
Inflows into municipal bond mutual funds returned as investors added $236.491 million, per Refinitiv Lipper data reported Thursday, versus the $698.782 million of outflows the week prior.
High-yield saw $548.733 million of inflows after $64.981 million of inflows the week prior. Exchange-traded funds saw inflows to the tune of $708.837 million after inflows of $31.792 million in the previous week.
In the primary market Thursday, BOK Financial Securities priced for the Belton Independent School District, Texas, (/AAA//) $166.230 million of unlimited tax school building bonds, Series 2022, with 5s of 2/2023 at 1.44%, 5s of 2027 at 1.98%, 5s of 2032 at 2.43%, 4s of 2037 at 3.36%, 4s of 2042 at 3.70%, 4s of 2047 at 3.89% and 4s of 2052 at 3.94%, callable in 2/15/2031.
Secondary trading
New York City TFA 5s of 2023 at 1.69%. Loudoun County, Virginia, 5s of 2023 at 1.61%. Delaware 5s of 2025 at 1.61%-1.60%.
Baltimore County 5s of 2027 at 1.90%. Georgia 5s of 2028 at 2.01%.
Texas waters 5s of 2032 at 2.36% versus 2.40% Wednesday. Georgia 5s of 2034 at 2.43% versus 2.47% Wednesday and 2.68% on 7/19. Washington 5s of 2036 at 2.71%.
Clemson University 5s of 2041 at 2.82% versus 2.88% Tuesday and 2.95%-2.94% on 7/22. Washington 5s of 2044 at 3.15%-3.14%. Ohio waters 5s of 2046 at 3.09%-3.08%.
New York City 5s of 2047 at 3.45%-3.44%. Los Angeles DWP 5s of 2052 at 3.19%-3.17% versus 3.33%-3.24% Monday.
AAA scales
Refinitiv MMD’s scale was bumped two to eight points at 3 p.m. read: the one-year at 1.38% (-2) and 1.60% (-5) in two years. The five-year at 1.80% (-8), the 10-year at 2.23% (-8) and the 30-year at 2.91% (-3).
The ICE AAA yield curve was mixed: 1.47% (+5) in 2023 and 1.60% (-7) in 2024. The five-year at 1.80% (-7), the 10-year was at 2.30% (-7) and the 30-year yield was at 2.90% (-6) at 3:30 p.m.
The IHS Markit municipal curve also saw bumps: 1.38% (-2) in 2023 and 1.62% (-5) in 2024. The five-year was at 1.82% (-8), the 10-year was at 2.23% (-8) and the 30-year yield was at 2.91% (-3) at a 3 p.m. read.
Bloomberg BVAL was bumped three to seven basis points: 1.35% (-3) in 2023 and 1.60% (-5) in 2024. The five-year at 1.84% (-5), the 10-year at 2.28% (-7) and the 30-year at 2.89% (-3) at 4 p.m.
Treasuries rallied 10 years and in.
The two-year UST was yielding 2.866% (-13), the three-year was at 2.805% (-14), the five-year at 2.692% (-15), the seven-year 2.699% (-14), the 10-year yielding 2.667% (-12), the 20-year at 3.226% (-7) and the 30-year Treasury was yielding 3.022% (-5) at the close.
FOMC redux
“The Fed is intent on pushing ahead with tightening despite early signs of economic weakness,” said Jeffrey Cleveland, principal and chief economist at Payden & Rygel.
Fed Chair Jerome Powell said a “rising unemployment rate would probably be required to slow inflation,” Cleveland noted.
“Instead of seeing growth weakness as a cause for concern, policymakers view such indicators as a sign of policy progress,” Cleveland said. “Policymakers ‘need a period of growth below potential to create slack.’
Given the inflation backdrop, he said that “the Fed will likely tighten into a downturn.”
“Historically, inflation as high as we are now experiencing only fell during/after a recession,” Cleveland said. “This time may not be different.”
At this time, the Fed funds rate is significantly below inflation, said Mickey Levy, chief economist for Americas and Asia at Berenberg Capital Markets and a member of the Shadow Open Market Committee.
He said a crucial issue moving forward is whether core inflation subsides. “While inflation is expected to recede from current levels, we expect it will remain far above the Fed’s 2% target,” he said.
But “because rate hikes are estimated to take six months or more to reach full impact on economic movement, the June rate hike likely had very limited impact on economic data since the June meeting,” said James Ragan, director of wealth management research at D.A. Davidson.
This means, he said, that July’s hike, along with June, totaling 150 basis points, “will have the largest slow down impact over the next several months, raising “the risk of recession.”
Tom Garretson, senior portfolio strategist at RBC Wealth Management, said July’s FOMC meeting “proved to be the Fed’s first step in pivoting back to a more-dovish approach to policy as rates are now at a neutral level for the economy, arguing that the Fed should take a more cautious approach from here and tip-toe their way to rates toward 3%.”
“If the first half of the year was the Fed providing explicit forward guidance to markets in terms of getting policy rates back to neutral, and expeditiously so, we have now see a return to a data-dependent approach as the Fed enters the next phase of monetary policy,” he said.
Ragan expects lower hikes in the meeting ahead, which could mean 50 basis points in September and 25 basis points in November and December, taking the fed funds to 3.25%-3.50%.
Garretson, though, believes there will 25 basis point rate hikes in September and November, “given the recent pullback in commodity prices, deteriorating economic momentum, early signs of cracks in the labor market and … more softness than Powell and the policy statement alluded to, before bringing the “current rate hike cycle to a pause at a 2.75-3.00% target policy rate.”
And “while the market and Fed estimates are generally aligned for the remainder of the year, a difference in opinions arises in 2023, with the Fed appearing to expect additional hikes at the start of the year [and] investors think the hiking cycle will be concluded by the end of this year,” said Marvin Loh, senior macro strategist at State Street Global Markets.
While the timing may be different, he said, “both the Fed and market think that after reaching terminal value (3.375% for market and 3.75% for Fed), it will be in a position to cut rates soon thereafter, getting back to neutral.”
Loh said the belief rate hikes will end within the next five months and cuts will be possible soon thereafter “has been a fairly constructive view for risk assets, which have generally rallied since the June FOMC meeting.”
This view, he noted, “is predicated on inflation convincingly behaving and the imbalance in the jobs market moving closer towards equilibrium.”
Loh believes it is too early “to call an all clear on these major requirements and therefore think that volatility will continue into the fall, at which point the Fed will have a better idea of peak rates for this cycle.” In the interim, he doesn’t think “the market can remain constructive around this view, which again, will either be affirmed, or need to be repriced within the next quarter.”
GDP falls 0.9%
The U.S. economy shrank for the second consecutive quarter from April to June, fueling worries that the economy was about to enter, or had already entered, a recession.
Gross domestic product fell 0.9% at an annualized pace for the second quarter, according to the advance estimate, a surprise for most of Wall Street and below Reuters’ estimate of a 0.5% gain. The decline follows a 1.6% decrease in the first quarter.
“The U.S. economy is weakening much faster than anyone expected,” said Edward Moya, senior market analyst at OANDA.
He noted a “meaningful slowdown was expected much later, so this second-straight contraction will complicate the Fed’s plan to aggressively fight inflation.”
The massive hit to growth, he said, was mainly driven by a 2.0% hit from inventories. “Consumer spending is cooling, but remains supportive for modest growth in the economy,” he added.
“There is, without doubt, an underlying slowdown in domestic demand in evidence here, with consumer goods spending and housing weakening,” said Brian Coulton, Fitch chief economist.
However, he said, “this number does not signal the early arrival of the inflation and Fed-tightening induced recession that markets have recently been focused on.”
The labor market, he noted, “remains resilient, consumer spending on services is picking up and the fall in GDP is more than accounted for by the short-term dynamics of the inventory cycle.”
Matt Peron, director of research at Janus Henderson Investors, concurred.
“While the headline GDP will generate much discussion, from an equity market standpoint we don’t think it will change the narrative much,” he said.
Despite the overall negative headline figure, he said that “consumer spending rose 1% as consumers continued to spend on services, despite moving away from goods” and importantly, “employment remains solid.”
“While there will be much handwringing over this headline, it does not add much to what we have been hearing from company managements, many of which are seeing softening demand and a fatigued consumer due to inflation concerns,” he said. “We continue to believe we are not out of the woods yet on the pressure the economy will feel from inflation and rate increases, and continue to recommend a defensive position within risk assets to weather the slowdown that is unfolding.”
Informa: Money market muni assets drop
Tax-exempt municipal money market funds lost $2.97 billion the week ending July 25, bringing the total assets to $98.78 billion, according to the Money Fund Report, a publication of Informa Financial Intelligence.
The average seven-day simple yield for all tax-free and municipal money-market funds fell to 0.38%.
Taxable money-fund assets added $26.19 billion to end the reporting week at $4.447 trillion of total net assets. The average seven-day simple yield for all taxable reporting funds rose to 1.24%.
Mutual fund details
In the week ended Wednesday, Refinitiv Lipper reported $236.491 million of inflows, following an outflow of $698.782 million the previous week.
Exchange-traded muni funds reported inflows of $708.837 million after inflows of $31.792 million in the previous week. Ex-ETFs, muni funds saw outflows of $472.346 million after $730.573 million of outflows in the prior week.
The four-week moving average was at negative $142.172 million from negative $530.561 million in the previous week.
Long-term muni bond funds had inflows of $739.331 million in the last week after inflows of $280.108 million in the previous week. Intermediate-term funds had outflows of $35.024 million after $266.672 million of outflows in the prior week.
National funds had inflows of $343.983 million after $553.979 million of outflows the previous week while high-yield muni funds reported $548.733 million of inflows after $64.981 million of inflows the week prior.