Munis play catch up, face another round of cuts
Municipals faced another weaker day with benchmark yield curves seeing two to four basis point cuts, underperforming a slightly better U.S. Treasury market, while equities ended in the red.
Munis played catch up to the large selloff in Treasuries since Friday, holding municipal to UST ratios steady. The five-year was at 54%, 68% in 10 and 79% in 30, according to Refinitiv MMD's
The Investment Company Institute reported a large drop of inflows into municipal bond mutual funds at
It marked the 45th straight week of positive flows into the long-term funds and exchange-traded funds saw inflows at
Inflation and Fed-related losses in U.S. Treasuries continue to weigh on municipals. However, tax-exempt outperformance is expected this month and next due to substantial built-in reinvestment demand, said
Last week, bond yields climbed again, with the curve bear-flattening in reaction to higher Fed forecasts and the economic effect of such expectations farther out.
Municipal benchmarks saw only minor corrections, with the majority of that occurring on Tuesday and Wednesday as a catch-up from the previous week.
“There remain highly conflicting economic data about; still rising infections and, most notably, COVID-related deaths, along with the lack of momentum for the Democrat’s Build Back Better stimulus bill, suggest, at a minimum, caution with respect to otherwise strong consumption and related growth,” Fabian said in a weekly Outlook report.
And inflation, even if it is a result of post-pandemic consequences, is likely to dampen growth if it puts downward pressure on employment and investment, he said.
Tax-exempt munis are still susceptible to flows and net supply. January was a particularly strong month for reinvestment demand compared to the previous year, and February is expected to be just as strong, Fabian said. However, when the market turns less optimistic in March, ongoing decline in Treasuries is more likely to lead to more unkempt tax-exempt weakness, he said.
Fabian said despite rising investor price discovery via the Bloomberg PICK system — at its highest level since 2019 — net customer trading activity continues strong. Net customer purchasing was the strongest of the year last week and even reclaimed its long-term trend line, Fabian said.
“In other words, while yields have risen, demand has not been interrupted, and credit spreads, reasonably, are still quite tight,” he said.
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Informa (IFPJF): Money market muni funds rise
Tax-exempt municipal money market fund assets increased their total by
The average seven-day simple yield for the 150 tax-free and municipal money-market funds remained at 0.01%.
Taxable money-fund assets lost
Secondary trading
Los Angeles Department of Water and Power 5s of 2039 at 1.71%. University of California 5s of 2040 at 1.78.
AAA scales
Refinitiv MMD's scale was cut two to four basis points at the
The ICE municipal yield curve was cut two to four basis points: 0.33% (+1) in 2023 and 0.56% (+2) in 2024. The 10-year was at 1.29% (+2) and the 30-year yield was at 1.72% (+3) in a
The IHS Markit (INFO) municipal analytics curve was cut two to four basis points: 0.37% (+2) in 2023 and 0.52% (+4) in 2024. The 10-year at 1.24% (+4) and the 30-year at 1.72% (+4) as of a
Bloomberg BVAL was cut two to four basis points: 0.39% (+2) in 2023 and 0.53% (+2) in 2024. The 10-year cut three to 1.27% and the 30-year up two to 1.70% at a
Treasuries were stronger, except on the two-year, and equities ended in the red.
The two-year UST was yielding 1.045%, the five-year was yielding 1.635%, the 10-year yielding 1.849%, the 20-year at 2.226% and the 30-year Treasury was yielding 2.16%, at the close. The Dow Jones Industrial Average lost 339 points or 0.96%, the S&P was down 0.97% while the Nasdaq lost 1.15%, at the close.
Rate hikes will bash bonds
After getting a taste of how the bond market might react to Federal Reserve rate hikes, analysts see the outlook for bonds worsening this year.
“More aggressive Fed interest rate hike expectations drove bond yields higher last week,” noted
In this environment, he suggested turning to high-yield municipal bonds, where “extra income improves return potential while issuers’ strong credit fundamentals mitigate default risk.”
Additionally, he said, “quantitative tightening would place modest upward pressure on bond yields.” Already, Treasury yields’ upward movement are a headwind for bonds.
While the Fed’s hawkish plans will have “only limited impact” on growth and most likely inflation, DWS Group U.S. Economist
But rising bond yields may be viewed “as in line with fundamentals and a solid economy, and this is consistent with our unfavorable rating on long-term fixed income,” said Wells Fargo Investment Institute Investment Strategy Analyst
Overall, they say, “higher Fed policy rate and rising bond yields can be viewed as a positive given they are more in line with fundamentals and a solid economy.”
“Inflation and interest rate concerns are going nowhere soon,” said
Markets have gotten used to central bank support, “and very gentle unwinding when appropriate,” he said. “This is quite a shock to the system.”
Inflation has been higher and stickier than expected, noted Anwiti Bahuguna, senior portfolio manager and head of multi-asset strategy at Columbia Threadneedle Investments. “If the various forces keeping inflation high ease next year, then the Fed can implement rate hikes in a measured fashion,” she said.
While inflation is high enough to justify rate hikes, she said, “the usually reliable labor market dynamics are much harder to discern. Sector-specific labor shortages are creating distortions in wage gains.”
Also, maximum employment is open to interpretation. “If we see continued inflationary pressure and improvement in the labor market, we may see a much swifter pace of action from the Fed,” Bahuguna said.
Data released Wednesday offered no good news on inflation. Housing starts climbed 1.4% in December to a seasonally adjusted 1.702 million annual rate, while building permits surged 9.1% to a seasonally adjusted 1.873 million annual pace.
Economists polled by IFR Markets expected starts to slip to 1.65 million and permits to fall to 1.701 million.
“As mortgage interest rates are rising and construction costs increase, affordability headwinds are steepening,” said National Association of Home Builders Chief Economist Robert Dietz.
This will add pressure to home prices, which “soared to record levels in 2021,” said
Separately, the Federal Reserve Bank of New York’s Business Leaders Survey showed slower growth in the region’s service sector as respondents see the business climate as below usual.
Employment saw modest gains while wages grew “at a solid clip,” the survey said. Prices paid and prices received indexes eased somewhat “but remained near record highs.”
Respondents expect better conditions six months ahead.
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