Municipal bonds were little changed Tuesday outside of the one-year as the Federal Reserve began its two-day meeting that will decide the direction of monetary policy. The primary market remained in low gear and will rev up slightly on Thursday.
U.S. Treasuries were better and equities rallied.
The three-year muni-UST ratio was at 54%, the five-year at 57%, the 10-year at 62% and the 30-year at 88%, according to Refinitiv MMD's 3 p.m. ET read. ICE Data Services had the three at 53%, the five at 56%, the 10 at 62% and the 30 at 88% at 4 p.m.
Despite municipal to Treasury ratios that are at 12-month lows, current market technicals are supporting strong valuations, according to Jason Appleson, PGIM Fixed Income's head of municipal bonds.
"The macro picture seems to be stabilizing as the Fed appears to be approaching the end of its hiking cycle," Appleson said.
"Inflation is cooperating, which has led to a decline in overall rate volatility," he said. "With this backdrop, investors have reentered open end mutual funds, which have led to spectacular returns so far this month."
January municipal bond issuance declined 17% year-over-year as issuers entered the new year facing uncertainty amid a rising rate environment, still too-high inflation and the possibility of recession.
Total volume for the month was $21.931 billion in 417 issues versus $26.292 billion in 770 issues a year earlier, according to Refinitiv data.
Appleson views the credit and political fronts as stable.
With the exception of healthcare, senior living, and development spaces, the other sectors of the market have been bolstered by COVID-era financial aid and better tax collections, driven by a "resilient economy and inflation," he noted.
"Despite contentious debt ceiling debates that are likely to last through the summer, we ultimately believe there will be a positive resolution," Appleson said of the political backdrop's impact on the municipal market.
"In the case of a delayed increase of the debt ceiling, the effects would largely be mechanical — rather than authorization risk," Appleson said.
"Many municipalities, highway funds/toll roads, and hospitals have sufficient liquidity for short-term disruptions," Appleson said.
Overall, the key driving forces in the municipal market, according to Appleson, are falling rate volatility — which has reversed flows back into the municipal markets — and limited supply.
"January is often a month that sees a seasonal rally, known as the 'January effect,' which is caused by limited supply and high reinvestment," he explained. "However, this year's technicals have super-charged the January effect," Appleson said.
With 30-day visible supply at $3.6 billion, the technical strength could easily last through February, if the macro-picture remains, according to Appleson.
"However, as macroeconomic releases continue to become a more critical part of the Fed's narrative, the market has become a data-junkie, reacting sharply to changes in trend," he said.
Still, short term, volatility may play an important role, Appleson said.
"Additionally, if the rate picture holds, we will likely see a reentry of issuers back into the market — especially in the context of the [Infrastructure Investment & Jobs Act], where federal dollars will augment local spending," he added.
The municipal market is expected to "outperform the historical seasonal trend in the first quarter and the full-year [2023] total returns to be positive for the Muni and HY Muni Indices," according to CreditSights strategists Pat Luby and Sam Berzok.
"With the market growing more comfortable that the Fed is making progress on controlling inflation, the peak in fed funds is now expected to occur in the first half of the year," they said. "We anticipate continued growth of the already strong demand from individual investors seeking to lock in yields before rates begin declining."
Because tax-exempt yields "are generally too rich to appeal to corporate investors subject to the 21% federal income tax rate, outperformance of the municipal market will depend on continued direct and indirect demand from individual investors," they said.
Any interruption or disruption of that demand, the CreditSights strategists said, "should be expected to result in exaggerated market volatility, which could potentially provide short-lived opportunities for banks, insurance companies and other IG investors to add municipal credit risk to their portfolios at favorable yields."
"Indirect demand via municipal bond mutual funds is always one of the most influential factors on the market," they said.
When mutual fund flows turn negative, they noted, "secondary market prices can be pressured lower if portfolio managers need to sell bonds to raise cash to pay exiting shareholders," while "primary market yields and spreads can also be affected when outflows persist long enough to cause a reduction in demand for new issue bonds."
In 2022, week after week of net outflows from mutual funds weighed heavily on the market. For the last 20 weeks of the year, CreditSights strategists said, net outflows totaled $61 billion. Some of that — about $15 billion — went into municipal bond exchange-traded funds.
"While we know from anecdotal reports that some money that left mutual funds went into [separately managed accounts], we also suspect that a meaningful percentage of it was taken out of the muni market," they said.
If non-negative fund flows continue, they expect "a boost in primary market demand and reduced selling pressure in the secondary market."
However, they don't expect supply to be picking up as quickly as demand. For 2023, CreditSights strategists forecast new issue volume will be around $415 billion, up 15% from 2022. New money issuance will be 7% higher than last year.
There will also be $90 billion of refunding only bonds, split evenly between tax-exempt and taxables, they said.
"While we expect about $45 billion of tax-exempt current refundings, we believe that any meaningful increase in advance refunding bond issuance will not happen until after the peak in fed funds," they said. "If fed funds peak lower or sooner than the market expects, the pace of new issue volume should pick up more quickly."
This year, they expect municipal bond redemptions to peak in June and July.
"While the return of invested principal can stoke reinvestment demand, we do expect that many institutional portfolio managers will be looking to pre-invest those funds prior to the actual redemption dates," the CreditSights strategists said. "The seasonal peak of reinvestment flows will help to provide technical support for the market."
In the competitive market Tuesday, South Windsor, Connecticut, (/AAA//) competitively sold $28.5 million of GOs. Citi won the bonds with a true interest cost of 3.1857%.
The East Montgomery County Municipal Utility District No. 12, Texas, sold $20.635 million of unlimited tax bonds. SAMCO Capital Markets won the issue with a TIC of 4.1924%.
Secondary trading
Washington 5s of 2024 at 2.33%. Georgia 5s of 2024 at 2.34%. Maryland 5s of 2024 at 2.27% versus 2.31% on 1/24 and 2.66% on 1/9.
NYC 5s of 2026 at 2.23%. LA DWP 5s of 2027 at 2.00%. California 5s of 2028 at 2.11% versus 2.35%-2.32% in 1/9.
NYC TFA 5s of 2037 at 2.95% versus 3.02% Monday. Columbus, Ohio, 5s of 2038 at 3.00%. Washington 5s of 2039 at 3.11% versus 2.97% original on 1/19.
Illinois Finance Authority 5s of 2047 at 3.99%-4.01% versus 4.32%-4.30% on 1/10. LA DWP 5s of 2052 at 3.40%-3.41% versus 3.42% Friday and 3.37% on 1/24.
AAA scales
Refinitiv MMD's scale was bumped at the one-year. The one-year was at 2.28% (-5) and 2.17% (unch) in two years. The five-year was at 2.05% (unch), the 10-year at 2.19% (unch) and the 30-year at 3.20% (unch) at 3 p.m.
The ICE AAA yield curve saw cuts on the short end: at 2.31% (+2) in 2024 and 2.23% (+1) in 2025. The five-year was at 2.07% (flat), the 10-year was at 2.17% (flat) and the 30-year yield was at 3.20% (flat) at 4 p.m.
The IHS Markit municipal curve was bumped at one-year: 2.31% (-2) in 2024 and 2.16% (unch) in 2025. The five-year was at 2.06% (unch), the 10-year was at 2.20% (unch) and the 30-year yield was at 3.18% (unch) at a 4 p.m. read.
Bloomberg BVAL was little changed: 2.32% (unch) in 2024 and 2.15% (unch) in 2025. The five-year at 2.10% (unch), the 10-year at 2.22% (unch) and the 30-year at 3.23% (unch).
Treasuries were better.
The two-year UST was yielding 4.185% (-7), the three-year was at 3.884% (-8), the five-year at 3.611% (-6), the seven-year at 3.566% (-6), the 10-year at 3.496% (-6), the 20-year at 3.762% (-3) and the 30-year Treasury was yielding 3.625% (-4) at 4 p.m.
Primary to come:
The Fort Worth Independent School District, Texas, (Aaa///) is set to price Thursday $277.370 million of PSF-insured unlimited tax school building bonds, Series 2023. Piper Sandler.
The Colorado Housing and Finance Authority (Aaa/AAA//) is set to price Thursday $125 million of taxable single-family mortgage bonds, including $84 million of Class I bonds, 2023 Series A-1, serials 2023-2033, terms 2038 and 2049; $21 million of Class II adjustable rate bonds, 2023 Series A-2, term 2043; and $20 million of GNMA MBS Pass-Through Program, Class I bonds, 2023 Series B, term 2053. RBC Capital Markets.
Competitive:
Newark, New Jersey, is set to sell $35.598 million of qualified general capital improvement bonds, Series 2023, at 11:30 a.m. eastern Thursday.
The Clark County School District Finance Corp., Kentucky, (A1///) is set to sell $22.645 million of school building revenue bonds, Series of 2023, at 12 p.m. eastern Thursday.
