Municipals were firmer following the Fed's decision to hike rates another 75 basis points, while U.S. Treasuries rallied on the short end and equities ended up.
Despite this being another “outsize rate increase” of 75 basis points, Brian Coulton, chief economist for Fitch Ratings, said “the Fed has still only raised interest rates back into line with its own estimates of the long-run neutral rate.”
Coulton said the Federal Open Market Committee's statement “acknowledged the recent softening in activity data but this is given short-shrift in the presence of what is still a very robust labor market and unrelenting inflation pressures."
“Given where core inflation and the unemployment rate currently stand this underscores that monetary policy adjustment still has quite a long way to go,” he said. “Market expectations that the Fed may be cutting rates again next year look premature."
Mauricio Agudelo, head of fixed income investments at Homestead Advisors, noted the Fed is still playing catch up to runaway inflation.
"We think inflation is still too high and they need to continue pressing forward with rate hikes and quantitative tightening," Agudelo said.
For the September meeting, the Fed will have the benefit of having multiple economic data points before deciding on the next move. The committee is taking a “wait and see” approach to the future path of Monetary policy," Agudelo noted.
For muni participants, they"are not without worries over the Fed’s tightening campaign, but cyclical forces and strong fundamentals have catalyzed positive returns for July, with the asset class doubling the returns shown for UST securities month-to-date,” said Jeff Lipton, managing director of credit research at Oppenheimer Inc.
Indeed, municipals are returning 2% so far in July.
“With the outperformance booked by munis, relative value ratios have become more expensive with shorter maturities still the richest,” he said.
Muni-UST ratios on Wednesday were at 67% in five years, 84% in 10 years and 98% in 30 years, according to Refinitiv MMD's 3 p.m. read. ICE Data Services had the five at 66%, the 10 at 88% and the 30 at 97% at a 3:30 p.m. read.
“While munis have moved further away from fair value, relative value remains far more compelling today compared with the more expensive ratios that existed throughout 2021,” Lipton said.
Demand for muni product has been strong this summer, and Lipton expects “market technicals to remain supportive through August with a likely continuation of positive performance.”
“As recessionary concerns intensify, a sustainable flight-to-quality trade should emerge with munis well positioned to offer investors a predictable revenue stream of tax-exempt income,” he said. “A repositioning of deployable cash into longer dated maturities may offer strategic value with more attractive total return should rates revert to lower ground, and so we suggest that curve extensions may be appropriate for those investors relatively unhindered by duration risk.”
The Investment Company Institute reported investors pulled $602 million out of muni bond mutual funds in the week ending July 20 compared to the $543 million of inflows in the previous week.
Despite fund flows returning to negative, Lipton believes “that stronger market conviction and less inflationary stress will temper the pace of outflows and likely produce a cycle of intermittent inflows or perhaps even a sustained period of positive flows.”
“While there may still be somewhat active bid wanted activity, we expect institutional selling pressure to subside with the availability of better relative value along the long end of the curve,” Lipton noted.
“There is a compelling list of muni tailwinds that provide fertile ground to extend the July performance momentum,” he said.
“Entry points are now attractive with munis poised to recover even more of their year-to-date losses, although it would be a reach to end the year in positive territory,” he added. “Greater comfort with Fed policy actions can make fixed income investment more compelling for those anxious investors starving for directional guidance and can pave the way for heavier allocations of capital into the muni asset class.”
Secondary trading
Connecticut 5s of 2023 at 1.44%. North Carolina 5s of 2023 at 1.48%-1.40%. Fairfax County, Virginia, 5s of 2026 at 1.81% versus 1.86% Tuesday.
New York City 5s of 2029 at 2.34% versus 2.50% on 7/20. California 5s of 2032 at 2.38%-2.34%.
Georgia 5s of 2034 at 2.47% versus 2.63% on 7/19. District of Columbia 5s 2034 at 2.64%-2.62% versus 2.76% on 7/20. California 5s of 2035 at 2.65%. Maryland 5s of 2035 at 2.52% versus 2.65% on 7/22.
Washington 5s of 2041 at 3.12%-3.11%. Washington 5s of 2044 at 3.17% versus 3.25% Tuesday.
Los Angeles Department of Water and Power 5s of 2051 at 3.24%-3.21%. New York TFA 5s of 2051 at 3.60%-3.58% versus 3.70%-3.65% Tuesday.
AAA scales
Refinitiv MMD’s scale was bumped up to three points at 3 p.m. read: the one-year at 1.40% (unch) and 1.65% (-2) in two years. The five-year at 1.88% (-3), the 10-year at 2.31% (-3) and the 30-year at 2.94% (unch).
The ICE municipal yield curve was bumped up to three basis points: 1.42% (flat) in 2023 and 1.67% (-2) in 2024. The five-year at 1.89% (-3), the 10-year was at 2.37% (-2) and the 30-year yield was at 2.96% (-1) at 3:30 p.m.
The IHS Markit municipal curve also saw bumps: 1.40% (unch) in 2023 and 1.67% (-2) in 2024. The five-year was at 1.90% (-2), the 10-year was at 2.31% (-3) and the 30-year yield was at 2.94% (unch) at a 3 p.m. read.
Bloomberg BVAL was bumped one to four basis points: 1.38% (-1) in 2023 and 1.64% (-2) in 2024. The five-year at 1.89% (-3), the 10-year at 2.34% (-4) and the 30-year at 2.91% (-3) at 3:30 p.m.
Treasuries were mixed.
The two-year UST was yielding 3.002% (-6), the three-year was at 2.957% (-7), the five-year at 2.854% (-5), the seven-year 2.854% (-4), the 10-year yielding 2.800% (-1), the 20-year at 3.304% (+2) and the 30-year Treasury was yielding 3.068% (+4) at the close.
FOMC reaction
The Federal Reserve hiked rates another three-quarter point, matching June's historic move.
“The Fed statement said they are still ‘highly attentive’ to inflation risks and that ongoing increases will be appropriate,” noted Edward Moya, senior market analyst at OANDA.
In his press conference, Fed Chair Jerome Powell stressed that he doesn’t believe the U.S. economy is currently in a recession, mostly because of the strength in the labor market and continued consumer spending.
As for future moves, Powell said there was “very broad support” for the 75-basis-point hike this meeting, which brings the fed funds rate “into the range of neutral.”
Decisions on future rate hike, he said, will be made on a meeting-by-meeting basis. He pointed to the latest Summary of Economic Projections and noted, “SEPs can get old quickly. This one remains a good guide” for the panel’s thinking. The latest SEP suggested a fed funds rate between 3.25% and 3.50% at the end of the year.
“Like other central banks, the Fed has thrown out forward guidance,” said Jason Brady, president and CEO at Thornburg Investment Management.
“This move is a breath of fresh air. In an era of uncertainty, we don’t need any central bank locking themselves in to a bad policy move, especially when they are communicating that they are data dependent," Brady said. "The worst mistake the Fed has made in some time was in the context of refusing to adapt quickly enough to changing circumstances.”
Brady noted it will be challenging for Powell “to maintain consensus in the future given a weakening of the economy with still very strong inflation.”
“Rocking the boat at this meeting has no great purpose,” he said.
Inflation above 9% is a fail, he said, and “they likely — and deservingly — feel like they need to allow themselves to be much more nimble.”
But if the Fed continues to favor data dependency, Brady said, “they will inevitably be reactive and therefore behind.”
Primary to come:
The Belton Independent School District, Texas, (/AAA//) is set to price Thursday $168.750 million of unlimited tax school building bonds, Series 2022, serials 2023-2052. BOK Financial Securities.
The Unified School District No. 489, Kansas, (/A+//) is set to price Thursday $143.500 million of general obligation refunding and improvement bonds, Series 2022-B. Piper Sandler & Co.
Pinal County, Arizona, (/AA/AA/) is set to price Thursday $115.560 million of taxable green pledged revenue obligations, Taxable Series 2022. Stifel, Nicolaus & Co.
The California Community College Financing Authority is set to price $107.575 million of Napa Valley College Project student housing revenue bonds, consisting of $93.905 million of senior bonds, Series A, terms 2032 and 2060, and $13.670 million of subordinate bonds, Series C term 2060. Citigroup Global Markets.
Gary Siegel contributed to this report.
