Municipal yields rose double digits Friday bringing levels to highs not seen since early April 2020. The short end of triple-A scales has risen more than 30 basis points over the past five sessions on elevated selling pressure and overall market volatility.
Triple-A yields rose by six to 10 basis points and ratios increased again as U.S. Treasuries saw small gains. The municipal to UST five-year was at 79%, 87% in 10 and 89% in 30, according to Refinitiv MMD's 3 p.m. read. ICE Data Services had the five at 75%, the 10 at 88% and the 30 at 92%.
Despite most investors predicting a difficult year, market volatility across all asset classes has shocked the majority of investors, according to Barclays PLC.
Municipals have already underperformed Treasuries, with current ratios surpassing Barclays' year-end projections.
"While they have adjusted from a historical perspective, they are not overly cheap, just closer to fair value," Barclays strategists Mikhail Foux, Clare Pickering and Mayur Patel said. "The front end has been under the most pressure, and we actually are starting to see more value in shorter-dated bonds for more defensive investors."
If there is continued market volatility and fund outflows, Barclays said, longer-dated bonds might struggle.
"We are especially cautious on longer-dated lower coupons bonds, which have already underperformed 5% bonds by 5-10 bp in the past month or so, but there is probably more downside as rates move higher, especially for long-dated 3% bonds.
"Overall, we feel that investors should be able to find some attractive opportunities in the near future. We would not be rushing to buy, but even at current levels some market participants should start slowly adding exposure," they said.
BofA Global Research said rate volatility will certainly impair fund flows and the market's main saving grace is a lack of supply, they said.
“If issuance starts picking up, we could see more market pressure,” they said. “However, after a stretch of time that featured poor valuations, we think we are starting to see some attractive opportunities in the coming weeks and months.”
Recent mutual fund withdrawals may have made portfolio managers wary, BofA said.
Mutual fund flows have historically been consistently negative when 10-year triple-A rates reach 50 basis points and stay high for three months; otherwise, outflows were always transient, they said. .
If the Fed's hawkish posture succeeds in limiting long-term Treasury rates, they said, muni market should follow suit.
“For the time being, we stay on muni curve flattening and emphasize the long end of the muni curve,” they said. “Should the Treasury curve flatten to such low levels, it may be a time to re-evaluate the curve position.”
The new issue calendar is about $8.07 billion with $6.274 billion of negotiated deals and $1.793 billion of competitive loans.
The largest deal of the week comes from Rayburn Country Securitization with $908.3 billion. Other notable deals include the Triborough Bridge and Tunnel Authority, Virginia Small Business Financing Authority, the Black Belt Energy Gas District, New York Liberty Development Corp. and the Department of Airports of the city of Los Angeles, California.
Massachusetts and Hampton, Virginia lead the competitive calendar.
Secondary trading
Carroll County, Maryland, 5s of 2023 at 0.75%. New York City Transitional Finance Authority 5s of 2023 at 0.78%. Wake City, North Carolina, 5s of 2024 at 0.95%.
Massachusetts 5s of 2026 at 1.26%. Georgia 5s of 2026 at 1.28%. Montana 5s of 2027 at 1.38%.
Georgia 5s of 2029 at 1.48%. Louisiana 5s of 2030 at 1.73%. Prince George's County, Maryland, 5s of 2031 at 1.56%.
Los Angeles Department of Water and Power 5s of 2036 at 1.88%. University of California 5s of 2038 at 1.97%. Los Angeles Department of Water and Power 5s of 2048 at 2.13%.
AAA scales
Refinitiv MMD's scale saw eight to 10 basis point cuts at the 3 p.m. read: the one-year at 0.61% (+8) and 0.89% (+10) in two years. The five-year at 1.21% (+10), the 10-year at 1.55% (+10) and the 30-year at 1.95% (+10).
The ICE municipal yield curve was cut five to nine basis points: 0.59% (+6) in 2023 and 0.91% (+8) in 2024. The five-year at 1.21% (+9), the 10-year was at 1.57% (+8) and the 30-year yield was at 1.92% (+6) in a 4 p.m. read.
The IHS Markit municipal curve was cut 10 basis points: 0.65% (+10) in 2023 and 0.88% (+11) in 2024. The five-year at 1.19% (+10), the 10-year at 1.53% (+10) and the 30-year at 1.97% (+10) at a 4 p.m. read.
Bloomberg BVAL was cut nine to 10 basis points: 0.65% (+9) in 2023 and 0.87% (+9) in 2024. The five-year at 1.21% (+9), the 10-year at 1.55% (+9) and the 30-year at 1.94% (+9) at a 4 p.m. read.
Treasuries were slightly better and equities rallied near the close.
The two-year UST was yielding 1.173%, the five-year was yielding 1.623%, the 10-year yielding 1.789%, the 20-year at 2.165% and the 30-year Treasury was yielding 2.094% at the close. The Dow Jones Industrial Average gained 564 points or 1.65%, the S&P was up 2.43% while the Nasdaq gained 3.13% at the close.
Preparing for tightening
Despite most analysts expecting four or five Fed rate hikes this year, and balance sheet reduction, expect volatility, but the municipal bond market should still do well.
“The muni market has a history of outperforming Treasuries when the Fed hikes because the tax-free interest that munis pay becomes more attractive as yields rise,” noted Ann Ferentino, portfolio manager at Federated Hermes. “While we expect muni to Treasury ratios to rise with the Fed moves, if the policy actions go at a measured pace, munis still should be well positioned relative to Treasuries.”
The market is buoyed by “robust credit quality, with low default rates, upgrades exceeding downgrades, strong revenue growth, significant federal support and recovering pension funds,” she said. The proof is “tight quality and sector spreads.”
While there could be bumps along the way, Ferentino said, “we expect the asset class to deliver reliable income streams and diversification throughout 2022.”
And while recession isn’t imminent, said Liz Young, head of investment strategy at SoFi, investors “are not conditioned for this environment and I don’t think the digestion process is over.”
“A treacherous bear market” is not in the cards she said, but when market relationships “dislocate” as they did last year, she said, “I start to sense something ominous on the horizon.”
The link between the 10-year Treasury yield and inflation, “the relationship between growth and value in the face of tightening monetary policy (value should have been a clearer winner), and the relationship between valuations and fundamental durability was rarely found,” Young said.
Recently, those “relationships have started to make more sense,” she said. “That tells me this needs to happen to bring us closer to rationality, and to set us up for the next phase of the economic cycle.”
Friday brought readings on inflation, wages and consumer sentiment.
The employment cost index rose 1.0% in the fourth quarter, down from a 1.3% rise in the third quarter. It was up 4.0% from a year ago.
Economists were expecting a 1.2% rise.
“While still blistering, the quarterly increase was more restrained than Q3's 1.3% gain,” said Wells Fargo Securities Senior Economist Sarah House. “That may tamp down fears of a wage-price spiral amid signs businesses are not upping pay at such a frenzied pace.”
With the gains slowing, Fed officials are likely “breathing a bit of relief that labor costs did not accelerate further on a sequential basis,” she said, “but glad they have telegraphed a more hawkish path for policy given that the overall pace of employment costs continue to point to a very tight labor market.”
But the improvement does not signal “the worst is over when it comes to labor cost growth,” House warned. “Amid an already tight labor market and the Omicron wave dealing a setback for the labor supply outlook, wage pressures are likely to remain firmly upward over the next few quarters.”
Olu Sonola, Fitch Ratings head of U.S. regional economics, said, "Labor shortages continue to pressure wages to the upside, particularly in the pandemic sensitive leisure and hospitality sector.”
While deceleration this quarter was broad based, the construction, trade and transport sectors were exceptions, Sonola said.
The report shows “an economy grappling with high inflation and the emergence of the Omicron variant of COVID-19,” said Erik Lundh, principal economist at The Conference Board. “We expect these data to worsen in January due to the spike in Omicron infections this month. Although, as this latest wave of COVID-19 passes we expect consumer spending growth to improve as spring approaches — particularly for spending on in-person services.”
After the Fed raises rates, said Grant Thornton Chief Economist Diane Swonk, “one has to wonder how well those wage gains will hold up.” In the past 20 years, information was “the only sector that came close to those kinds of wage gains.”
Consumer spending declined 0.6% in December following a 0.4% increase in November as the personal consumption expenditures price index rose 0.4% in the month and 5.8% for the year. The annual gain, up from 5.7% in November was the biggest jump since 1982.
Core PCE gained 0.5% in the month and 4.9% year-over-year, the largest annual gain since 1983.
“Consumers pivoted back into services, including travel, tourism and health care over the month as they opted to see their loved ones instead of buying traditional holiday gifts,” said Swonk. “Spending on goods of all types contracted over the month.”
Omicron could tamp spending in January, she noted.
“Inflation is beginning to bite and suppress spending and consumers’ assessments of the economy,” Swonk added. “Federal Reserve Chairman Jay Powell delivered a much more hawkish tone at the press conference following the FOMC meeting. It is past time; panic within the Fed’s ranks has begun to set in. The challenge now is to tamp down inflation without allowing the flame on the overall economy to go out. There is no road map for doing this after inflation has surged.”
Consumer sentiment slipped in January, with the University of Michigan’s consumer sentiment index falling to 67.2, its lowest level since November 2011, from 68.8 in mid-January and 70.6 in December.
The current conditions index fell to 72.0 from 74.2 in December and expectations dropped to 64.1 from 68.3.
Primary to come:
Rayburn Country Securitization is set to price next week $908.289 million of senior secured cost recovery bonds, consisting of $205.399 million of Series 2022 Class A-1, term 2032; $353.327 million of Series 2022 Class A-2, term 2043; and $349.623 million of Series 2022 Class A-3, term 2051. Jefferies.
Triborough Bridge And Tunnel Authority (/AA+/AA+/AA+/) is set to price Friday $650.915 million of payroll mobility tax senior lien bonds, Series 2022A, serials 2034-2042, terms 2047, 2052 and 2057. Ramirez & Co.
Virginia Small Business Financing Authority (/BBB-/BBB//) is set to price Thursday $627.625 million of tax-exempt/alternative minimum tax senior lien revenue refunding bonds, Series 2022. J.P. Morgan Securities.
The Black Belt Energy Gas District (Baa1//A-/) is set to price Thursday $490.78 million of gas project revenue bonds, 2022 Series A. Goldman Sachs & Co.
New York Liberty Development Corp. is set to price Wednesday $449.19 million of green tax-exempt liberty revenue refunding bonds, Series 2022A, consisting of $355.19 million of Series 1 (Aaa///), $58.8 million of Series 2 (Aa3///) and $35.2 million of Series 3 (A2///). Goldman Sachs & Co.
Department of Airports of the city of Los Angeles, California, (Aa3/AA-/AA-/) is set to price Tuesday $412.275 million, consisting of $293.845 million of private activity/alternative minimum tax subordinate revenue and refunding revenue bonds, 2022 Series C, serials 2024-2042, terms 2045 and 2049; $99.895 million of private activity/non-alternative minimum tax subordinate refunding revenue bonds, 2022 Series D, serials 2023-2035; and $18.535 million of governmental purpose/non-alternative minimum tax subordinate refunding revenue bonds, 2022 Series E, serials 2026-2039. Loop Capital Markets.
City of San Antonio, Texas, Electric and Gas Systems (Aa3/A+/AA-//) is set to price Tuesday $347.865 million of fixed and variable rate junior lien revenue refunding bonds, Series2022, serials 2026-2044, term 2049. Jefferies.
Tarrant County Cultural Education Facilities Finance Corp., Texas, (Aa3/AA-///) is set to price Thursday $215.68 million of hospital revenue bonds, Series 2022. UBS Financial Services.
Arlington Independent School District, Texas, (Aaa/AAA//) is set to price Wednesday $195.035 million of unlimited tax school building and refunding bonds, Series 2022, serials 2023-2047, insured by Permanent School Fund Guarantee Program. Siebert Williams Shank & Co.
Broward County, Florida, (Aa1/AA+///) is set to price Wednesday $178.67 million of water and sewer utility revenue bonds, Series 2022, serials 2028-2043, term 2047. Siebert Williams Shank & Co.
Clifton Higher Education Finance Corp., Texas, (/AAA//) is set to price Wednesday $173.005 million of variable rate education revenue bonds, Series 2021T, serials 2022-2042, terms 2047 and 2050, insured by Permanent School Fund Guarantee Program. Baird.
Upper Arlington City School District, Ohio, is set to price next week $125.23 million of unlimited tax general obligation revenue bonds, consisting of $55.71 million of Series A, serials 2032-2037, terms 2040, 2044 and 2048; $64.545 million of Series B, serials 2022-2028, terms 2052 and 2055; $4.975 million of Series A-CAB, serials 2022-2031. Stifel, Nicolaus & Co.
Georgetown Independent School District, Texas, (Aaa/AAA//) is set to price daily $103.88 million of taxable unlimited tax refunding bonds, Series 2022-A, insured by Permanent School Fund Guarantee Program. FHN Financial Capital Markets.
Massachusetts State College Building Authority (Aa2/AA-///) is set to price Wednesday $102.86 million of project and refunding revenue bonds, Series 2022A, serials 2023-2042, terms 2047 and 2052. Jefferies.
National Community Renaissance of California (/A+///) is set to price Thursday $100 million of taxable social corporate CUSIP bonds, Series 2022, serial 2032. Morgan Stanley & Co.
Competitive:
Massachusetts (Aa1/AA/AA+/) is set to sell $300 million of general obligation bonds consolidated loan of 2022, Series A at 10 a.m. eastern Tuesday.
Massachusetts (Aa1/AA/AA+/) is set to sell $350 million of general obligation bonds consolidated loan of 2022, Series A at 10:30 a.m. Tuesday.
Hampton, Virginia, is set to sell $117.37 million of general obligation public improvement bonds, Series 2022A at 10 a.m. eastern Thursday.
