Municipals were weaker Thursday amid increased secondary selling pressure, while U.S. Treasury yields rose 10 years and in after the unanticipated decline in first-quarter gross domestic product. Equities rallied.
Triple-A yield benchmarks were cut up to three basis points, while USTs saw the largest losses inside of 10 years.
Muni to UST ratios were at 84% in five years, 94% in 10 years and 104% in 30, according to Refinitiv MMD's 3 p.m. read. ICE Data Services had the five at 84%, the 10 at 96% and the 30 at 106% at a 4 p.m. read.
Investors pulled more from municipal bond mutual funds in the latest week, with Refinitiv Lipper reporting $2.875 billion of outflows, though down from $3.548 billion of outflows in the previous week.
In the primary Thursday, Morgan Stanley priced for the Michigan Finance Authority (Aa3/AA//) $803.305 million of Beaumont-Spectrum Consolidation hospital revenue refunding bonds, Series 2022. Bonds in 10/2022 with a 5% coupon yield 2.08%, 5s of 4/2027 at 2.88%, 5s of 4/2032 at 3.34%, 5s of 4/2037 at 3.58% and 4s of 4/2042 at 4.05%.
An uptick in new-issue and secondary volume leading up to the end of the month has had little negative impact on yields, as benchmarks have been running in place for the last few sessions, said Kim Olsan, senior vice president at FHN Financial.
Bids wanteds are still running high, with Wednesday's totals hitting $2.286 billion, but Olsan said tax-exempt yields have caught a modest bid-side as USTs bounce within an approximate 10-basis-point range.
“Higher real yields also have a pivotal role in allocations, as a large contrast to the early 2021 period when the slope was steeper (10s/5s was a healthy 50 basis points) but raw levels were 200 basis points lower,” she said.
Olsan said large-scale issuers have found “newfound demand from buyers capitalizing on the yield pullback.” A $1.9 billion University of California Medical Center issue priced Aa3/AA- bonds in an upsized pricing, a phenomenon largely absent this year.
“The 5s due 2033 yielded 3.20% (115%/UST) and a 5% due 2047 yielded 3.78% (130%/UST) — with each roughly spread 20-30 basis points wide to the state’s GOs and in a name that offers sector diversity for in-state inquiry,” Olsan noted.
With month-end considerations winding down, she said the focus has turned to the upcoming supply-demand component. Selling pressure persists with bids wanteds in competition reaching a two-plus-year high of $2.29 billion Wednesday, according to Bloomberg. It's the third time bids wanteds has topped $2 billion this year.
And between May’s redemptions and projected supply, Olsan noted the net figure is at near parity at $16 billion on each side. The big caveat is “what occurs with fund flows in coming weeks.”
She said “floundering flows have been a main contributor to this year’s weakness," Olsan said, pointing to the Investment Company Institute's most recent report of a
Olsan noted that ownership within the fund complex shows a potential shift occurring in how individuals are participating in the market.
Muni
As ETFs have grown in the muni space, attracting more crossover buyers as rates have risen, return figures for actively traded muni ETFs show mixed results in recent quarters against the broad market.
During 2021, ETF returns were modestly negative against a 1.5% return in the broad market, Olsan pointed out. In 1Q22, returns either tracked or lagged a main index. April’s steep yield pullback has forced a generic loss of over 2%.
"As a broad category muni fund holdings totaled $987 billion at the end of 2021, a 43% increase over the last five years," she said. "At the household level, total municipal assets have grown just 17% in that same period."
Morgan Stanley investment strategists Matthew Gastall and Daryl Helsing note that while interest rates have risen across the municipal yield curve, the more “pronounced impacts have been in bonds with shorter final maturities.”
“This ‘bear flattening’ has occurred as investors have anticipated that the Federal Reserve will continue raising its target fed funds rate to help control inflation,” they said in a Wednesday report.
Gastall and Helsing said such beliefs can have a considerable “multiplier effect on shorter-maturity bond prices.”
“As front-end yields have risen faster than those of longer maturities,” they have seen the “peak-to-trough slopes of the UST and municipal bond yield curves flatten by approximately 130 and 60 basis points, respectively.”
While these bear-flattening movements have happened often throughout history, Morgan Stanley strategists said “the total slope of 2-year to 30-year maturities (2s/30s) has rarely been this distinct.”
These are comparable levels breached in 1989 and 2007, when “financial professionals … advocated that investors 'lock up' yields in longer maturities as the possibilities of recession, lower interest rates, and Fed rate cuts had become apparent.” But currently, they said “it’s clear that markets are, instead, preparing for the possibilities of higher interest rates due to inflationary considerations and potential Fed rate hikes.”
Morgan Stanley strategists said recent developments have pushed “some short-end municipal yields to reach their highest levels documented since 2008,” excluding March 2020.
"These rates may continue to increase and cause volatility, but it’s important to note that such price movements are often limited in deviation since many of the bonds’ maturities are set to pay par in the near future," they wrote. "Hence, interim price action may be less of a concern for buy-and-hold investors.“
Secondary trading
Maryland 5s of 2023 at 2.07%-1.88%. California 5s of 2023 at 2.13%-2.11%. Maryland 5s of 2024 at 2.18%. NY Dorm PIT 5s of 2025 at 2.50%. North Carolina 5s of 2025 at 2.44%-2.45%.
Florida Board of Education 5s of 2030 at 2.69%-2.68% versus 2.45%-2.47% original (on 4/13). NYC TFA 5s of 2031 at 3.02%-2.98%. Georgia 5s of 2033 at 2.85%-2.81% versus 2.55% on 4/12 and 2.43% on 4/7.
The University of North Carolina at Chapel Hill 5s of 2036 at 2.88% versus 2.91% on Wednesday. NY Dorm PIT 5s of 2037 at 3.46%-3.42% versus 2.97%-2.96% on 4/7.
NYC Municipal Water Finance Authority 5s of 2051 at 3.63%-3.62% versus 3.70%-3.69% on Friday, 3.64%-3.63% on 4/19 and 3.42%-3.41% on 4/12. LA DWP 5s of 2051 at 3.50% versus 3.43% on Tuesday, 3.38% on 4/19, 3.23% on 4/14 and 3.09% on 4/11.
Triborough Bridge and Tunnel Authority 5s of 2057 at 3.84%-3.83% versus 3.80%-3.79% a week ago and 3.37% on 4/7.
AAA scales
Refinitiv MMD’s scale was cut two basis points outside of two years at the 3 p.m. read: the one-year at 1.94% (unch) and 2.20% (unch) in two years. The five-year at 2.43% (+2), the 10-year at 2.70% (+2) and the 30-year at 3.05% (+2).
The ICE municipal yield curve was cut one to three basis points: 1.95% (+1) in 2023 and 2.26% (+1) in 2024. The five-year at 2.43% (+2), the 10-year was at 2.70% (+2) and the 30-year yield was at 3.12% (+3) at 4 p.m.
The IHS Markit municipal curve was cut two basis points outside of five years: 1.96% in 2023 (unch) and 2.21% (unch) in 2024. The five-year at 2.43% (unch), the 10-year was at 2.67% (+2) and the 30-year yield was at 3.05% (+2) at 4 p.m.
Bloomberg BVAL was cut up to two basis points: 1.93% (unch)in 2023 and 2.19% (+1) in 2024. The five-year at 2.445 (+1), the 10-year at 2.68% (+1) and the 30-year at 3.00% (+2) at the close.
Treasury yields rose.
The two-year UST was yielding 2.640% (+5), the three-year was at 2.800% (+5), five-year at 2.867% (+4), the seven-year 2.890% (+3), the 10-year yielding 2.849% (+2), the 20-year at 3.113% (flat) and the 30-year Treasury was yielding 2.918% (flat) near the close.
Primary on Wednesday:
Barclays Capital priced for the Regents of the University of California (Aa3/AA-/AA-/) $1.1 billion of taxable medical center pooled revenue bonds, 2022 Series Q. All bonds price at par: 4.132s of 5/2032 and 4.563s of 2053. Make whole call.
Mutual funds see outflows
In the week ended April 27, weekly reporting tax-exempt mutual funds saw investors pull more money out with Refinitiv Lipper reporting $2.875 billion of outflows Thursday, following an outflow of $3.548 billion the previous week.
Exchange-traded muni funds reported inflows of $287.580 million after outflows of $272.100 million in the previous week. Ex-ETFs, muni funds saw outflows of $3.162 billion after $3.276 billion of outflows in the prior week.
The four-week moving average widened to negative $3.444 billion from negative $3.235 from in the previous week.
Long-term muni bond funds had outflows of $2.153 billion in the last week after outflows of $1.926 billion in the previous week. Intermediate-term funds had outflows of $351.972 million after $576.627 million of outflows in the prior week.
National funds had outflows of $2.440 billion after $3.083 billion of outflows the previous week while high-yield muni funds reported $729.260 million of outflows after $678.839 million of outflows the week prior.
Informa: Money market muni assets rise
Tax-exempt municipal money market fund assets added $675.5 million, bringing it up to $90.99 billion for the week ending April 26, according to the Money Fund Report, a publication of Informa Financial Intelligence.
The average seven-day simple yield for the 148 tax-free and municipal money-market funds rose from 0.13% to 0.14%.
Taxable money-fund assets added $34.40 billion, bringing total net assets to $4.347 trillion in the week ended April 12. The average seven-day simple yield for the 774 taxable reporting funds rose from 0.12% to 0.13%.
GDP contracts
The 1.4% contraction in the first-quarter gross domestic product did not faze analysts, who still view the economy as pretty strong, attributing the decline to a growing trade deficit and smaller inventory growth.
And, they said, the Federal Reserve will still raise rates 50 basis points and start balance sheet reduction.
“Inverted yield curves and negative GDP growth are scary, but the underlying details of today's GDP report are consistent with our forecast for slow growth,” said Wells Fargo Securities Senior Economist Tim Quinlan. “A negative print for GDP does not warrant any additional distress or worry about potential recession.”
Still “the underlying domestic demand backdrop was solid in Q1,” said Mickey Levy, Berenberg Capital Markets' chief economist for the U.S. Americas and Asia, and a member of the Shadow Open Market Committee. Personal consumption grew, and showed a shift toward services from goods, business investment “was robust” and residential investment gained.
“The Fed understands these details and should proceed with a decision to raise rates 50 basis points and begin unwinding the balance sheet at its FOMC meeting next week,” he said.
Grant Thornton Chief Economist Diane Swonk agreed. “The domestic economy held up much better than those figures suggest.”
Considering consumer spending, housing and business investment, which she called “the three pillars of the private sector, added 3.2% to growth in the first quarter,” better than the 2.4% contribution they made the quarter before. “The most important aspects of the domestic economy held up better than they did at the end of 2021, when growth was soaring.”
However, the negatives included: “inventory accumulation slowed despite ongoing shortages; government spending contracted even faster than we saw in the fourth quarter when much of the pandemic aid lapsed; the trade deficit blew up.”
COVID, the Russian invasion of Ukraine and Chinese lockdowns, Swonk said, “took a greater toll on growth abroad than at home.”
But the U.S. “resilience has spurred inflation and left the Fed scrambling to raise rates,” she said. “The challenge will be for the Fed to cool domestic demand without sending too much of a chill through the labor market. Getting policy ‘just right’ is no easy feat. Goldilocks only exists in fairy tales.”
This negative read does not signal the beginning of a recession, said David Page, head of macro research at AXA Investment Managers. “Nevertheless, the Fed will be wary of the underlying slowing in the economy. We continue to see further underlying deceleration into H2 2022, reducing the need for Fed hikes on the scale envisaged by markets.”
A one-quarter contraction was expected, Page said, but not until later this year. “The fact that the pace of inventory correction started sooner likely means that future growth will be more consistent over the remaining quarters of this year.”
The 2.8% growth Page expects this year is below the 3.2% consensus, and the fed funds rate of 2.5% at yearend is also below market expectations of 2.75%.
And while the report won’t deter the Fed from its planned actions next week, David Kelly, chief global strategist at JPMorgan Asset Management, said, the report highlights “the risk in raising rates too aggressively for the rest of the year.”
Second-quarter “growth should bounce back,” he said, but “the fact that inventories were still growing at a very elevated $158.7 billion annual pace in the first quarter should limit the rebound.”
The deficit suggests “the U.S. dollar is very overvalued relative to other global currencies,” he said. “If geopolitical uncertainty diminishes and the Fed takes a slightly less hawkish stance, the dollar could begin to decline from its current very high levels.”
While the Fed will proceed with a rate hike and balance sheet reduction despite the contraction, Will Compernolle, senior economist at FHN Financial, said, “another quarter or two of sluggish growth will complicate its ‘whatever it takes’ commitment to fighting inflation.”
Although fighting inflation remains the Fed’s priority, he said, “consumption will weaken as high inflation takes a bite out of paychecks and rising prices for essentials like food and gas leave less for discretionary spending.”
