Municipals continued their ascent to higher yields Wednesday, even before the Federal Open Market Committee said it would "soon" raise interest rates.
U.S. Treasury yields spiked following the FOMC statement and Chairman Jerome Powell's comments.
"Powell’s seeming unwillingness to dismiss some of the more-hawkish scenarios for the path of policy this year, leaving all options on the table, is clearly having a negative impact on market sentiment," said Tom Garretson, senior portfolio strategist at RBC Wealth Management.
Secondary trading showed high-grade state names trading upwards of double digits over triple-A benchmarks on bonds inside 10-years, but weakness was seen along the entire curve. Trading slowed to a trickle after the Fed news but muni activity throughout the morning into the early afternoon led to two to eight basis point cuts to scales, with larger cuts again up front.
Ratios rose were range-bound on the day's moves with the municipal to UST five-year at 62%, 74% in 10 and 83% in 30, according to Refinitiv MMD's 3 p.m. read. ICE Data Services had the five at 63%, the 10 at 78% and the 30 at 84%.
The Investment Company Institute reported $119 million of outflows from municipal bond mutual funds in the week ending Jan. 19, down from $142 million of inflows in the previous week.
It marked the first week of outflows after 45 straight weeks of positive flows into the long-term funds. Exchange-traded funds saw inflows at a mere $1 million after $460 million of inflows the previous week.
Early trading showed more pressure on the short end with a large block of Georgia 5s of 2023 at 0.56%, last traded in blocks at 0.21% on Dec. 3. Similarly, a block of Texas 5s of 2023 traded at 0.62% versus 0.26% on Dec. 22. Dallas water 5s of 2025 traded at 1%. New York Dormitory Authority personal income tax 5s of 2027 were at 1.17%.
A larger adjustment this month is taking place inside 2027 as munis react to USTs, correcting ratios as a result.
Kim Olsan, senior vice president at FHN Financial, noted that absolute yields in play in that range are indicative of a 10-year bond at the start of the month and short-end ratios have corrected 20 percentage points off recent lows.
“The extent of the current yield correction might be expected in March or October, when supply usually ramps up at the same time implied demand through redemptions wanes,” said Kim Olsan, senior vice president at FHN Financial. “But to happen in January — when the market almost always rallies — carries more weight.”
She noted, some yields have doubled on certain trades from their 2021 closing levels. A bids wanteds of Harvard University 5s of 2026 on Tuesday resulted in a 1.05% sale to a customer, nearly 50 basis points above its 2021 closing price.
“Participants in both primary and secondary markets will find some of the best entry points in years while issuers are still enjoying historically low rates,” she said.
Daily bid list volume remains quite elevated, with this month’s daily bid volume 47% higher than January 2021. Tuesday’s total was $1.2 billion, per Bloomberg data, “giving bidders unusual access to product at a time in the year when there are supposed to be more buyers than sellers,” Olsan noted.
It was the fourth time this month that bids wanteds crossed the billion mark. Bids wanteds reached more than $1 billion only twice in 2021, both times in February.
The factors contributing to the pullback “may not be so short-lived given the macro monetary picture, creating consternation for future commitments.”
Olsan looked at rate direction over the last several years that may be instructive for the coming weeks.
Since 2017, the 10-year AAA yield has averaged 1.62%, she noted. It traded through 0.75% in the second half of 2020 and ran as high as the 2.75% area in the fall of 2018. Excluding the “exogenous event of March/April 2020, the last period the yield traded at its median was summer 2019." At that time, the 10-year UST level was around 2%, creating a ratio near 80%.
Refinitiv MMD's triple-A 10-year is at 1.37% as of Wednesday.
“A move back toward the median yield would equate to another 25-30 basis point backup,” she said.
In the last five years, the 30-year AAA yield median has been 2.28% on a much steeper muni curve. The lowest range was through 1.50% between July and December of 2020 and again during the summer of 2021. Its upper yield range occurred late in 2018 when the level neared 3.50%.
The 30-year sits at 1.79%.
“Any effort to trade back toward the median yield would mean another 50 basis point adjustment from present levels,” she said.
Current trading is accounting for a tightening cycle — bringing on a bear flattener in the muni curve — a possible pickup in fund outflows and curve reallocations.
“In the prior tightening cycle that began in December 2015 and ended December 2018, the muni curve slope averaged 179 basis points, as compared to the current slope of 135 basis points,” she said.
In the primary Wednesday, BofA Securities priced for Montgomery County Higher Education and Health Authority, Pennsylvania, (A2/A//) $649.265 million of Thomas Jefferson University revenue bonds, Series 2022B. Bonds maturing in 5/2024 with a 5% coupon yield 0.95%, 5s of 2027 at 1.5%, 5s of 2032 at 2.02%,4s of 2037 at 2.38%, 4s of 2042 at 2.55%, 4s of 2027 at 2.76%, 5s of 2047 at 2.56%, 4s of 2052 at 2.86%, 5s of 2052 at 2.66%, 3.25s of 2057 at 3.41%, 3.125s of 2057 at 3.29%, 4s of 2057 at 3.01% and 5s of 2057 at 2.81%, callable 5/1/2032.
BofA Securities also priced for Thomas Jefferson University (A2/A//) $593.255 million of taxable revenue bonds, Series 2022A. Bonds maturing in 11/2023 priced at 1.725%t par, 2.673% in 2027, 3.031% in2032, 3.401% in 2037, 3.602% in2042 and 3.847% in 2057, callable 5/1/2057.
Ramirez & Co. priced for Austin Independent School District, Texas, (Aaa///) $352.855 million. The first tranche, $92.87 million of unlimited tax school building bonds, Series 2022A, saw bonds maturing in 8/2022 with a 5% coupon yield 0.50%, 5s of 2027 at 1.25%, 5s of 2032 at 1.61%, 2.375s of 2037 at 2.45% and 2.5s of 2041 at 2.61%, callable 8/1/2031.
The second tranche, $100.395 million of unlimited tax refunding bonds, Series 2022B, saw bonds maturing in 8/2027 with a 5% coupon yield of 1.25%, 5s of 2032 at 1.61% and 2.375s of 2036 at 2.42%, callable 8/1/2031.
The third tranche, $28.72 million of unlimited tax refunding bonds, Series 2022C, saw bonds maturing in 8/2028 with a 5% coupon yield of 1.4%, 5s of 2032 at 1.65% and 4s of 2033 at 1.77%, callable 8/1/2031.
The fourth tranche, $50.52 million of taxable unlimited tax refunding bonds, Series 2022D, saw bonds maturing in 8/2026 with a 5% coupon yield 1.718%, 5s of 2027 at 1.818%, 4s of 2032 at 2.333% and 2.633s of 2035 on par, callable 8/1/2032.
The fifth tranche, $80.35 million of taxable unlimited tax refunding bonds Series 2022E, saw bonds maturing in 8/2025 with a 5% coupon yield 1.526%, 5s of 2027 at 1.968% and 2.333% in 2031 at par.
Citigroup Global Markets priced for Charlotte-Mecklenburg Hospital Authority, North Carolina, (Aa3/AA-//) $118.065 million of health care refunding revenue bonds, Series 2022A. Bonds maturing in 1/2023 with a 5% coupon yield 0.51%, 5s of 2027 at 1.22%, 5s of 2031 at 1.64% and 4s of 2043 at 2.3%, callable 1/15/2032.
Secondary trading, pre-FOMC
Montgomery County, Maryland, 5s of 2023 at 0.60%. New York City TFA 5s of 2023 at 0.69%-0.68% versus 0.63% Monday. King County, Washington, 5s of 2023 at 0.61%.
Fairfax County, Virginia, 5s of 2025 at 0.99%. California 5s of 2026 at 1.22%.
Oregon 5s of 2029 at 1.32%. New York City 5s of 2030 at 1.49%. California 5s of 2032 at 1.49%-1.48% versus 1.12%-1.11% on Dec. 28. Maryland 5s of 2034 at 1.56% versus 1.52% Tuesday and 1.42% Friday.
Los Angeles Department of Water and Power 5s of 2039 at 1.76%-1.75% versus 1.66% on Jan. 20 and 1.59% original. University of California 5s of 2046 at 2.2%. Ohio Water Development Authority 5s of 2046 at 1.86%. DASNY 5s of 2049 at 2.2%.
Trading was sparse after the Fed with a few notable trades: Wisconsin 5s of 2023 at 0.55%. Ohio water 5s of 2023 at 0.54%. California 5s of 2027 at 1.27%.
AAA scales
Refinitiv MMD's scale saw two to three point cuts at the 3 p.m. read: the one-year at 0.43% (+2) and 0.69% (+3) in two years. The five-year at 1.03% (+3), the 10-year at 1.37% (+3) and the 30-year at 1.77% (+3).
The ICE municipal yield curve was cut two to eight basis points: 0.46% (+6) in 2023 and 0.75% (+8) in 2024. The five-year at 1.05% (+6), the 10-year was at 1.43% (+5) and the 30-year yield was at 1.81% (+4) in a 4 p.m. read.
The IHS Markit municipal curve was cut one to two basis points: 0.45% (+1) in 2023 and 0.67% (+1) in 2024. The five-year at 1.02% (+2), the 10-year at 1.36% (+2) and the 30-year at 1.80% (+2) as of a 4 p.m. read.
Bloomberg BVAL was cut one to five basis points: 0.47% (+1) in 2023 and 0.68% (+4) in 2024. The five-year at 1.02% (+4), the 10-year at 1.38% (+3) and the 30-year at 1.79% (+3) at a 4 p.m. read.
Treasuries sold off after the FOMC news and equities were mixed to end the day.
The two-year UST was yielding 1.156% (+14), the five-year was yielding 1.684% (+12), the 10-year yielding 1.877% (+10), the 20-year at 2.247% (+8) and the 30-year Treasury was yielding 2.183% (+7), at the close. The Dow Jones Industrial Average lost 130 points or 0.38%, the S&P was down 0.15% while the Nasdaq gained 0.02% at the close.
FOMC/Powell
The Federal Open Market Committee’s post meeting statement provided information about rate hikes (appropriate “soon”), expectations asset purchases will end in early March and principles for balance sheet reduction, with few specifics.
In his post-meeting press conference Fed Chair Jerome Powell elaborated a bit but said the panel hasn’t discussed if a 50 basis point increase in the fed funds rate target could be appropriate or the exact timing and pace of balance sheet runoff.
“With inflation well above 2% and a strong labor market, the Committee expects it will soon be appropriate to raise the target range for the federal funds rate,” the statement said. In his post-meeting press conference, Fed Chair Jerome Powell said, “The committee is of a mind to raise rates at the March meeting” if economic conditions are appropriate to do so.”
“The Fed is on track to raise rates at the March meeting,” said Subadra Rajappa, head of U.S. rates strategy at Societe Generale, “but concerns over the pandemic remain,” especially the potential for a slowdown related to the Omicron variant.
The balance sheet reduction principles say it will start after liftoff and will occur "over time in a predictable manner primarily by adjusting the amounts reinvested of principal payments received from securities held."
Powell would only commit to moving “sooner and perhaps faster” than last time, but the pace of reduction, the balance sheet composition and how far it will be cut are still to be determined.
The statement said the labor market is “strong,” noted Brian Coulton, Fitch Ratings chief economist, “no more references to waiting for maximum employment.”
While the Fed will monitor “how Omicron impacts payrolls in January and February, but it sounds like they are confident it will not unduly weaken labor market conditions,” he added. “The statement on balance sheet reduction suggests the run-off is likely to start in the second half of the year.”
But the statement led Steven Oh, global head of credit and fixed income at PineBridge Investments, to expect balance sheet reduction this summer. “The indication of earlier quantitative tightening in conjunction with rate hikes tilts the meeting toward a more hawkish outcome, resulting in a spike up in Treasury yields.”
Doug Duncan, chief economist, Fannie Mae, noted the Fed “met the market’s expectations on three points. First, they confirmed they will end their asset purchases in early March. Second, they confirmed they will raise the Fed funds rate shortly thereafter. And third, they expanded on their comments about principles guiding the reduction of the Fed’s portfolio.”
While the details were few, he noted, “Eventually they want to only hold Treasuries. For the mortgage market that matters.”
Runoff should follow the 2018 plan, Duncan said, where “they limited how much they would let mature each month. And if more than their limit would run off, they would buy back the difference.”
When asked how much in runoff would be equal to a quarter point rate hike, “Powell said there was not a rule of thumb,” he added.
The statement “continued the process of preparing the markets for interest rate liftoff in March,” said Northeast Investors Trust Chairman and Portfolio Manager Bruce Monrad. By noting “financial conditions ‘remain accommodative,’” he said, Fed officials will continue to use the phrase “to remind markets and critics that they believe interest rates still remain below the neutral level.”
From the Powell press conference, Monrad thought it interesting that the chair said, “interest rates could comfortably be raised without impairing the labor markets.” COVID risks appear to be accounted for, he said since “Powell made mostly perfunctory reference to downside risks facing the economy.”
“The Fed may feel forced to use its rhetoric to demonstrate that it means business with respect to inflation,” Monrad said. “Having said that, in response to a backhanded question about whether a 50 basis point rise was in the cards, Powell mostly quashed that thinking.”
While Powell said QT would “run in the background,” Monrad said, “the Fed may find that tightening financial conditions by reducing its balance sheet is a more opaque and useful complement to the difficult tradeoffs often surrounding raising interest rates.”
Expect continued market volatility, said Mauricio Agudelo, head of fixed income investments at Homestead Funds. Balance sheet reduction is “complicated,” he said. “The balance sheet will shrink via a reduction in the amounts reinvested of principal payments received from securities held (preference to let securities roll off).”
Primary to come
Brightline West Passenger Rail Project (Aaa///) is set to price Thursday $894.3 million, Series 2020A, consisting of $774.3 million of Series 1 and $150 million of Series 2. Morgan Stanley & Co.
The Black Belt Energy Gas District (Baa1//A-/) is on the day-to-day calendar with $498.92 million of gas project revenue bonds (Project No. 8), 2022 SERIES A. Goldman Sachs & Co.
The Ohio Housing Finance Agency (Aaa///) is set to price Thursday $175 million of social non-alternative minimum tax residential mortgage revenue bonds, 2022 Series A, serials 2022-2033, terms 2037, 2042, 2047, 2052 and 2052. Citigroup Global Markets.
Forney Independent School District, Texas, (/AAA//) is set to price on Thursday $152.585 million of unlimited tax school building bonds, Series 2022A, insured by Permanent School Fund Guarantee Program. FHN Financial Capital Markets.
