Municipals continued on the unchanged path with sparse trading and no primary to speak of for guidance, keeping the asset class in idle mode to end 2021.
The Investment Company Institute reported $91 million of inflows into municipal bond mutual funds in the week ending Dec. 15, down from $517 million in the previous week.
It marked the 41st straight week of positive flows into the long-term funds and brought the total inflows for this year to about $82 billion.
Exchange-traded funds saw a $569 million uptick in inflows after $168 million of inflows the previous week.
Triple-A benchmarks were left unchanged and ratios were mostly static. The five-year was at 48%, 70% in 10 and 80% in 30, according to Refinitiv MMD's 3 p.m. read. ICE Data Services had the five at 47%, the 10 at 72% and the 30 at 80%.
Thirty-day visible supply is at $2.6 billion with Bloomberg data pointing to $14.413 billion of net negative supply.
Informa: Money market muni funds fall
Tax-exempt municipal money market fund assets lost $406.6 million, bringing their total down to $86.01 billion for the week ending Dec. 22, according to the Money Fund Report, a publication of Informa Financial Intelligence.
The average seven-day simple yield for the 150 tax-free and municipal money-market funds fell to 0.01% from 0.03% the previous week.
Taxable money-fund assets gained $62.46 billion, bringing total net assets to $4.539 trillion in the week ended Dec. 22. The average seven-day simple yield for the 778 taxable reporting funds was 0.01%, down from 0.02% a week prior.
Build back blank slate?
The setback in Democrats' plans for their Build Back Better bill will have tangible market impacts, according to Morgan Stanley.
The firm's base case, what they call a BBB zombie effort, makes negotiations continue but in a different form, with the possibility of tax increases and less ambitious spending lingering. But passage remains uncertain, they said.
The version of Build Back Better that included $1.7 trillion of new spending and tax credits, offset by a mix of corporate and individual taxes, is off the table.
Recent declines in Treasury yields appear to reflect the Federal Reserve’s increased desire to fight inflation, as evidenced by declining breakevens, the report aid. "This effectively also reflects low expectations for further fiscal expansion from BBB. Hence Fed policy appears more influential to rates in the near term than fiscal."
The important part for munis is that "tax risks continue to linger as they are preserved as a potential offset for whatever level of spending all 50 Democratic senators can agree to, but potential approval of the legislation remains a question mark all year in the absence of hard deadlines for passage."
Given that certain pandemic-era provisions are set to expire at the end of this calendar year, Sen. Joe Manchin and other Democratic lawmakers "have an incentive to continue their talks to salvage some elements of the initial package, including perhaps a means-tested version of the proposed Child Tax Credit extension or some clean energy-related funding," the report said. "Net/net, the overall price tag of the legislation — if passed — shrinks substantially, along with the deficit impact."
Any BBB backup plan would almost certainly include tax hikes, and corporate taxes would still rise, albeit in a different way, the report said. Given political limits on raising the corporate tax rate, a "skinny" version of the BBB would likely preserve the corporate alternative minimum tax as a potential financing vehicle.
Even if there is no BBB, Morgan Stanley analysts said a 2022 requirement for corporations to amortize research and development, and software development spending over five years for tax reasons is an overlooked near-term cash-flow risk.
This requirement is a fiscal element of the Tax Cuts and Jobs Act, and if the BBB act had passed as written, it would have been deferred until the end of 2025. The near-term cashflow burden for R&D and software-intensive industries is significant: Morgan Stanley analysts anticipate that a higher tax liability will result in a 15% reduction in free-flow cash for these companies.
“Ultimately, we believe Congress will intercede and prevent this measure from taking effect, but the timing and legislative mechanism is highly uncertain without BBB passage,” they said. “Hence, taxpayers must plan and budget for current law and corporates will need to make requisite quarterly estimated tax payments, which could drag on near-term [free-cash flow] — even if intervention is likely.”
Will inflation mean higher rates?
With the yearend approaching, many economists believe inflation will moderate next year, but remain high enough for the Federal Reserve to raise rates.
But not everyone agrees.
“It remains to be seen whether inflationary pressures absolutely mean higher rates next year,” said Jeff Klingelhofer, co-head of investments Thornburg Investment Management. “The driving cause of inflation is critically important to understand when it comes to determining how quickly and by how much the Fed will raise rates — and in this case we think this will largely depend on whether inflation is predominantly driven by rising wages or by the ongoing supply-demand imbalances.”
While higher wages would elevate inflation, it would not be a large increase since “we’re coming off multiple decades of suppressed wages,” he said. But, if inflation results from supply-demand imbalances, Klingelhofer expects the Fed to “act more aggressively to rein in inflation and won’t allow the markets to run hot.”
But inflation remains a complex issue, noted BCA Research. “While there will be less inflation from the prices of commodities and durable goods, there will be more inflation from the elimination of output gaps, tightening labor markets and an overall dearth of global spare capacity,” they said.
And, BCA believes, “markets are underestimating how much the funds rate will have to rise over the next 2-3 years as the Fed belatedly catches up to a very tight U.S. labor market and inflation persistently above the Fed’s 2% target.”
They expect rate hikes to begin in June, with one additional 25 basis point hike each quarter of 2022. “We think it’s likely that consensus estimates of a 2.0% to 2.5% long-run neutral fed funds rate will turn out to be too low, but we don’t recommend trading on that view in 2022,” BCA said.
Plus, COVID will remain an issue in 2022, said Nigel Green CEO of deVere Group. “Whilst the markets have largely shrugged off the impact of the Omicron variant, there is still no certainty about how it will play out in the longer term,” he said. If infection rates soar, it could mean new restrictions.
“How will it impact the workforce?” he asked. “How will already shaky supply chains be managed?” These unanswered questions, Green said, can impact the investors and the economy.
Rising debt combined with higher rates could be disastrous for the U.S., Manhattan Institute, senior fellow Brian Riedl said. Higher debt levels haven’t been an issue since interest rates have been low, but “over the next 30 years, steeply rising debt will likely add more upward pressure on interest rates, while the offsetting factors could weaken or even reverse their effects,” he said.
Even without any new legislation that increases spending, Riedl said, using Congressional Budget Office figures, interest on the national debt in 30 years would cost half of all tax revenues, rising if interest rates do. Even assuming interest rates no higher than 3%, he said, “the debt would still reach 167% of the economy, with annual deficits of 10% of the economy in three decades.”
Despite this, consumer confidence gained in December, rising to 115.8 from 111.9 (1985=100), while the present situation index slipped to 144.1 from 144.4 and the expectations index grew to 96.9 from 90.2.
Economists polled by IFR Markets expected a 110.2 level.
“This is the second consecutive monthly increase in consumer confidence despite numerous headwinds, including elevated inflation and a surge in COVID cases from the highly-contagious omicron variant,” noted Scott Anderson, chief economist at Bank of the West. “The percentage of consumers planning to buy an automobile, home or major appliance over the next six months all increased.”
The report showed consumer less worried about inflation “after hitting a 13-year high last month” and “COVID-19, despite reports of continued price increases and the emergence of the Omicron variant,” said Lynn Franco, senior director of economic indicators at The Conference Board. “Looking ahead to 2022, both confidence and consumer spending will continue to face headwinds from rising prices and an expected winter surge of the pandemic.”
Also released Wednesday, existing home sales rose 1.9% to a seasonally adjusted annual pace of 6.46 million in November but were down 2.0% from a year ago.
Inventory dropped to 1.11 million units, off 9.8% from October and 13.3% lower than last November.
Prices grew, with the median price at $353,900, 13.9% above year-ago levels.
“Buyers continued to snap up available homes, as for-sale listings only lasted 18 days on the market,” said Joel Kan, Mortgage Bankers Association AVP of Economic and Industry Forecasting. “This swift competition continues to exert upward pressure on sales prices, overall home-price growth, and is impacting prospective first-time buyers.”
Separately, the final third quarter gross domestic product was revised to show 2.3% growth in the final read, up from the 2.1% gain in the earlier estimate.
Also, the Federal Reserve Bank of Chicago’s national activity index suggested “growth moderated in November.”
Secondary trading
Trading was thin. Wisconsin 5s of 2022 at 0.17%-0.15%. North Carolina 5s of 2023 at 0.24%. Iowa Finance Authority green bond 5s of 2023 at 0.27%.
Frisco, Texas, ISD 3s of 2025 at 0.47%. Minnesota 4s of 2026 at 0.58%.
Los Angeles MTA 5s of 2030 at 0.91%-0.90%. Connecticut 5s of 2035 at 1.37%-1.36%. New York City 5s of 2036 at 1.49%-1.42% (1.44% on 12/14).
Alexandria, Virginia, 2s of 2041 at 2.02%. Katy, Texas, ISD 3s of 2041 at 1.55%-1.48%.
Washington 4s of 2046 at 1.67%-1.54%. Humble, Texas, ISD 2.25s of 2047 at 2.38%.
AAA scales
Refinitiv MMD's scale was unchanged: the one-year at 0.14% and 0.24% in 2023. The 10-year sat at 1.03% and at 1.48% in 30.
The ICE municipal yield curve showed yields were little changed: 0.15% in 2022 and 0.27% in 2023. The 10-year steady at 1.04% and the 30-year yield at 1.49%.
The IHS Markit municipal analytics curve steady: 0.16% in 2022 and to 0.25% in 2023. The 10-year at 1.01% and the 30-year at 1.48% as of a 3 p.m. read.
Bloomberg BVAL was unchanged: 0.17% in 2022 and 0.22% in 2023. The 10-year was at 1.04% and the 30-year at 1.48%.
Treasuries were flat while equities improved.
The five-year UST was yielding 1.221%, the 10-year yielding 1.459%, the 20-year at 1.882% and the 30-year Treasury was yielding 1.855% at 3:20 p.m. eastern. The Dow Jones Industrial Average gained 185 points, or 0.52%, the S&P was up 0.70% while the Nasdaq gained 0.78% at 3:20 p.m. eastern.
Jessica Lerner contributed to this report.
