Municipals traded stronger across the yield curve Wednesday, following an early rally in U.S. Treasuries after inflation data came in softer than anticipated.
While Treasuries pared back some of those gains after the Federal Reserve held rates steady and the post-meeting statement signaled only one rate cut may come this year and spoke of "modest" progress in tamping inflation, municipal momentum continued throughout the session.
In what was a somewhat atypical move for the asset class on Fed day, triple-A muni yields fell five to eight basis points, depending on the curve, as the lack of a new-issue supply shifted investor attention to the secondary where recent new-issues traded up. Treasuries closed the session with gains of five to nine basis points with the stronger performance in the three to 10-year portion of the curve.
"It is important to remember that as long as the Fed's next move is to lower policy rates, bonds will do well," said Jack McIntyre, portfolio manager at Brandywine Global. "The employment market is in better balance, which is very important for the Fed — even more than inflation."
"As we move into the second half of the year, monetary policy will take a backseat to the forecasted fiscal spending programs that will be pushed by both presidential candidates heading into the November election," he said. "More rate cuts will be shifted into 2025 from 2024, which makes sense as the timing of this economic cycle continues to mature. Still, data remains more important than any future Fed-speak."
Few deals priced Wednesday while Bond Buyer 30-day visible supply ticks up to $10.39 billion.
At BlackRock, Patrick Haskell, head of the municipal bonds group, James Schwartz, head of municipal credit research, and Sean Carney, CIO of municipal bond funds, believe issuance "will remain elevated ahead of the election and negate some of the tailwind typically provided by seasonal net negative supply during the summer."
They noted the muni market's May selloff "has started to restore value to the asset class, but there are several reasons why patience is still warranted."
While much improved, valuations are still below their longer-term averages, they noted in a monthly performance report.
The two-year muni-to-Treasury ratio Wednesday was at 66%, the three-year at 67%, the five-year at 67%, the 10-year at 66% and the 30-year at 84%, according to Refinitiv Municipal Market Data's 3 p.m. EST read. ICE Data Services had the two-year at 65%, the three-year at 65%, the five-year at 66%, the 10-year at 66% and the 30-year at 82% at 4 p.m.
The BlackRock report said they expect demand "to remain subdued until the path of monetary policy becomes clearer and interest rates stabilize."
"Given this backdrop, we have started to selectively add duration, taking advantage of concessions in the new-issue market," they added.
Fund flows also have fluctuated, depending on the week and the data source.
The Investment Company Institute Wednesday reported $587 million of outflows from municipal bond mutual funds for the week ending June 5 following $156 million of inflows the week prior.
Exchange-traded funds saw larger inflows though, at $795 million following outflows of $97 million the week prior.
LSEG Lipper last week reported inflows during the same time period where they say investors added $549.2 million to the funds after $94.9 million of outflows the week prior.
AAA scales
Refinitiv MMD's scale was bumped five to eight basis points: The one-year was at 3.15% (-5) and 3.11% (-5) in two years. The five-year was at 2.90% (-7), the 10-year at 2.84% (-8) and the 30-year at 3.73% (-6) at 3 p.m.
The ICE AAA yield curve was bumped five to eight basis points: 3.21% (-5) in 2025 and 3.15% (-5) in 2026. The five-year was at 2.91% (-7), the 10-year was at 2.87% (-8) and the 30-year was at 3.73% (-8) at 4 p.m.
The S&P Global Market Intelligence municipal curve was bumped basis points: The one-year was at 3.20% (-5) in 2025 and 3.13% (-4) in 2026. The five-year was at 2.91% (-5), the 10-year was at 2.88% (-8) and the 30-year yield was at 3.73% (-6), at 4 p.m.
Bloomberg BVAL was 3.19% (-7) in 2025 and 3.14% (-7) in 2026. The five-year at 2.92% (-7), the 10-year at 2.85% (-7) and the 30-year at 3.74% (-6) at 4 p.m.
Treasuries were firmer.
The two-year UST was yielding 4.764% (-7), the three-year was at 4.514% (-8), the five-year at 4.332% (-9), the 10-year at 4.332% (-7), the 20-year at 4.574% (-5) and the 30-year at 4.487% (-5) at the close.
FOMC details
The Federal Open Market Committee expects just one rate cut this year, according to the Summary of Economic Projections, down from three in the previous dot plot, and kept the fed funds rate target at a range between 5.25% and 5.50%.
All officials now see rates ending the year at 4.875% or higher. They project four cuts in 2025. In the March projections, Fed officials expected three cuts this year and three next year. Four officials expect no cuts this year, while eight expect two reductions.
Inflation projections ticked up to 2.6% this year from 2.4% in the March estimates. Unemployment projections for the year grew to 4.2% from 4.1% in the prior SEP. The long-term neutral rate rose to 2.8% from 2.6% in March.
The SEP update was notable with an expected increase in the long-run median fed funds rate to 2.8% from 2.6%.
"This is consistent with a growing belief the neutral rate is higher than originally assumed as the economy remains stronger than expected in the face of notably higher rates," said Lon Erickson, portfolio manager at Thornburg Investment Management. "Of course, we will only know for sure after the fact, so we all need to tread carefully there."
The decrease in cuts projected, he said, is "not necessarily meaningful, especially if the cut is simply moved from December 2024 to January 2025."
The SEP surprise, according to ING Chief International Economist James Knightley, was growth and unemployment forecasts for 2024 were unchanged while the inflation forecast was increased. "We think they will start in September with a high chance they end up cutting rates by more."
"The 2024 cut priced in the market remains a coin flip, which will be likely decided by inflation in Q3," said Giuseppe Sette, president of Toggle AI.
"Reducing their median expectation to one rate cut in 2024 definitely raises the bar and it makes it is clear that they want to see a consistent trend of disinflation entrenched in the data," said Olu Sonola, Fitch Rating's head of U.S. research. "The bottom-line is that a rate cut during the second half of 2024 should not be taken for granted, despite the window of opportunity that today's CPI print seemed to have presented."
In his press conference, Federal Reserve Board Chair Jerome Powell said the number of rate cuts will be based on data and reiterated the Fed wants further confidence that the totality of data shows inflation moving sufficiently toward its 2% target.
Officials, he said, can change projections when data, such as the consumer price index are released the second day of the meeting. He said sometimes officials change their projection but wouldn't confirm whether that happened at this meeting.
Policy is restrictive, whether it's sufficiently restrictive will be answered in time, Powell said.
Michael Gregory, deputy chief economist at BMO Economics, said they still expect two cuts this year — September and December — since "there will be three CPI and personal consumption expenditures reports along with three employment reports," Gregory said. "There is plenty of time, and data, for the FOMC to shift its assessment from 'modest' further progress to a sufficient degree of 'confidence-building' progress to start cutting policy rates."
Brian Rehling, head of Global Fixed Income Strategy at Wells Fargo Investment Institute, said he expects two rate cuts this year and one next year.
If inflations slow more than expected, the "Fed may have to catch up," he said during the firm's midyear outlook held Tuesday.
But he expects the yield curve to remain inverted "until the Fed gets more aggressive" cutting rates.
