The Federal Open Market Committee meeting kept activity in the municipal bond market to a minimum on Wednesday. The meeting concluded with a decision to raise the fed funds rate target to a range of 2% to 2.25%, the third increase this year and eighth since the FOMC started raising rates in 2015. Policy makers removed the word “accommodative” from the post-meeting statement.
The Summary of Economic Projections, or dot plot, signals another 25 basis point increase by yearend, most likely at the December meeting. The forecast still sees rates growing to 3.4% by the end of 2020, and holding there in 2021. The median estimate of the long-term neutral rate ticked up to 3.0% from 2.9%.
Growth and job gains have been “strong” and inflation remains near the central bank's 2% target, the Federal Open Market Committee said in its statement Wednesday following a two-day meeting in Washington.
Barring a negative surprise in the economy, updated “dot plot” forecasts made a December rate hike almost certain, as the number of FOMC officials expecting another increase by year-end grew to a bigger majority of 12, from eight in the previous round of projections in June.
According to Jeffrey Lipton, managing director at Oppenheimer & Co. Inc., indications of a more hawkish sentiment may continue to pressure tax-exempt yields higher — particularly on the short end of the curve.
Meanwhile, as tax-exempts navigate the final quarter of 2018, they will likely do so against a number of headwinds.
While there are varying expectations for supply throughout the balance of the year, Lipton said he expects to see a constructive path that may help to support performance.
“We think that the light issuance this week will be well received as deployable cash remains available,” Lipton noted. “While reinvestment demand is expected to ebb through the final quarter, we see a contained diminution as tax-efficient investment holds its appeal for a large segment of the muni market.”
He added, municipal bond fund flows are likely to finish the year at a net-positive position.
“Moving throughout the fourth quarter, we do expect to witness episodic outflows, but again we are fairly confident that market technicals should sustain positive flows, which should help to support market recovery and performance,” Lipton said.
Federal Reserve flow of funds data would indicate the new lower corporate tax rate of 21% has contributed to institutional sales of longer maturity holdings, according to Lipton, who said that is a key contributor to negative performance on longer-dated bonds.
"Banks in particular have pared back their exposures to tax-exempts given a diluted incentive to owning these securities," he said. "We suspect that the rate of portfolio liquidations among banks will likely ease through the second half of the year with stabilization setting in sometime next year.
“While it is too soon to draw any enduring conclusions, we do think that any measure to extend the definition of HQLA to municipal securities would incentivize banks to buy and hold tax-exempt muni investments,” Lipton added.
Primary market
There was not much activity in the new issue space on Wednesday, with most deals being slated either on Monday and Tuesday before the Fed meeting or afterwards on Thursday.
On the schedule for Thursday, Piper is slated to price the San Dieguito, California, School Facilities Finance Authority’s $90 million of special tax revenue bonds. The deal is rated AA-minus by S&P Global Ratings.
Secondary market
Municipal bonds were little changed on Wednesday, according to a late read of the MBIS benchmark scale. Benchmark muni yields rose less than one basis point in the one- to 30-year maturities.
High-grade munis were also little changed, with yields calculated on MBIS' AAA scale rising less than one basis point in the one- to seven-year and nine- to 30-year maturities and falling less than a basis point in the seven and eight year maturities.
the Municipals were steady on Municipal Market Data’s AAA benchmark scale, which showed the yield on both the 10-year muni general obligation and the yield on 30-year muni maturity remaining unchanged.
On Wednesday, the 10-year muni-to-Treasury ratio was calculated at 85.1% while the 30-year muni-to-Treasury ratio stood at 101.4%, according to MMD. The muni-to-Treasury ratio compares the yield of tax-exempt municipal bonds with the yield of taxable U.S. Treasury with comparable maturities. If the muni/Treasury ratio is above 100%, munis are yielding more than Treasury; if it is below 100%, munis are yielding less.
Data appearing in this article from Municipal Bond Information Services, including the MBIS municipal bond index, is available on The Bond Buyer Data Workstation.
