Municipals ended the week facing continued pressure, particularly on bonds inside 10 years, while U.S. Treasuries made gains on the week and equities sold off led by tech stocks.
Triple-A yield curves were cut from one to four basis points, with the biggest cuts from the two to five-year part of the curve, while U.S. Treasuries saw yields fall two to five basis points.
Ratios rose with the day's moves with the municipal to UST five-year at 59%, 73% in 10 and 83% in 30, according to Refinitiv MMD's 3 p.m. read. ICE Data Services had the five at 59%, the 10 at 76% and the 30 at 84%.
The new issue calendar falls to $4.95 billion, with $3.804 billion of negotiated deals and $1.143 billion of competitive loans. The largest deal of the week comes from the Brightline West Passenger Rail Project with $894.3 billion and other notable deals scheduled from the Airport Commission of the City and County of San Francisco, Connecticut Health And Educational Facilities Authority Yale offering and several Texas PSF school deals.
Worcester, Massachusetts and Spartanbury County School District #5, South Carolina lead the competitive calendar.
Thirty-day visible supply is at $8.01 billion while net negative supply sits at $13.3 billion.
Returns are in the red with the Bloomberg Municipal Index at negative 1.32%, while high-yield sits at negative 1.12%. Taxable munis saw losses of 2.09% in the first three weeks of 2022 and the Municipal Impact Index saw losses of 1.58%.
While a minor rally took hold in November and held rates steady until the end of the year, January has witnessed a complete yield reversal and volatility return to its mid-November levels, noted Kim Olsan, senior vice president of municipal bond trading at FHN Financial.
Generic yields have given up 15%-25% of their actual yields this month — 10-year off 25% and the 30-year weaker by 15% from the close of 2021.
“The combination of steady supply, heavy secondary selling and inconsistent demand (the market saw its first fund outflow in 10 months) have moved most of the major spots to their highest levels since May 2020,” she said. “Following late 2021’s seller’s market, this month has turned decidedly into a buyer’s bias. With more syndicate issues engaged as the month progresses, bid list volume is becoming exaggerated, albeit with a short-end bent.”
Total bids wanteds it $1.36 billion Thursday, the most since April 2020. That level disrupts otherwise orderly secondary flows, which compete with an active primary market, Olsan said.
The biggest negotiated issue of the week ended up repricing to higher yields. The longest maturities of New York City's Transitional Finance Authority revenue bonds were cut by three basis points after already cutting levels by six to 11 basis points from Wednesday's retail offering. She noted the 4s of 2051 getting done at 2.37% was about 25 basis points above the long U.S. Treasury. A large school price in Dallas, Texas yielded a 30-year 2.75% at 2.77%, not far off where long-dated zero coupon bonds are trading.
That describes the current status of the market: It is in flux and still trying to reach an equilibrium where more demand can be produced, according to Olsan.
“Based on ultra-low ratios inside five years, this area of the curve has shown the greatest pullback in light of expected Federal Open Market Committee actions,” Olsan said.
The current 5s/2s spread is at 33 basis points, up from 28 basis points at the end of November and7s/2s is almost steady at a 55 basis point spread. What has changed is the actual yield increase in seven-year maturities, which has risen from roughly 0.85% in November to an indicated 1.13% level, over 40 basis points higher than the taxable equivalent yield, she said.
In the intermediate range, extension is being less rewarded in terms of yield pickup, but higher rates offer more interesting options, she said. The 10-year triple-A spot closed November at 1.05% and is now trading close to 1.30%, hitting over a 2% taxable equivalent yield. A similar trend has occurred in 15 years, where coupon variety can be met with taxable equivalent yields that approach 3%, according to Olsan
The 20s/10s spread is slightly flatter at 26 basis points at the long end of the curve. Actual yield points, which have retraced to March 2021 levels, have had a greater impact, she said. Olsan said long-term duration has developed, with purchasers in the 21% bracket buyers realizing taxable equivalent returns of over 3% and top-bracket people achieving taxable equivalent yields of over 4%.
Volatilities in the risk asset market have been on the rise as the Fed is on a faster pace to reduce its monthly asset purchases in preparation for an eventual rate hike, according to BofA Securities analysts.
None of this appears to them to have deterred bond bears in recent weeks, they said.
Bearish sentiment in the Treasury market has run very high as the bond market priced in four Fed rate hikes for 2022 starting in March. The 10-year Treasury yield rose to 1.9% on Wednesday and the 30-year to 2.21%. 10-year triple-A rates entered their buying zone as well. Yields for all maturities climbed more than 20 basis points and, in the 3-4 year maturities, 30-plus basis points, they said.
Both tax-exempt and taxable triple-A curves in the muni market have completely priced in four Fed rate rises in 2022. As a result, the market should start trading on the potential hazards of such pricing, as well as a continuous supply/demand mismatch for tax-exempt bonds in the future, they said.
BofA Securities strategists predict the muni market rise to be more persistent and directional by the second half of 2022, with the Fed on track to raise rates and inflation perhaps declining. During the first three weeks of the year, there was no evidence of credit spread widening in either tax-exempt or taxable munis. The spreads on high-yield muni indexes have even narrowed, owing to better credit circumstances in the wider muni market.
The year-to-date bond market selloff has resulted in losses for all indices, with longer maturity index results being increasingly worse. Although the muni triple-A curve has flattened year-to-date, the flattening is minor and insufficient to compensate for differences. Because triple-A-rated and triple-B-rated muni indices have longer maturities, they underperform double-A-rated and single-A-rated indexes. The spread movements of all four credit indices are nearly coordinated. Larger spreads and shorter periods helped soften the shock of rate changes in high yield munis, resulting in a lesser loss.
“Taxable munis have largely followed Treasuries this year, and fared slightly better than corporates. The Taxable Muni index returned -2.25% year-to-date, while the Corporate Master index returned -2.51%,” they said.
This year, the taxable muni index to corporate index spread should mostly stay negative and go much lower. Overall, credit conditions in the municipal market are improving, and credit spreads are marginally smaller than in 2021. Credit spread lows in the corporate sector were frequently set in mid-year 2021. Significant widenings have been seen by this period.
“Fed policy in 2022 will likely generate more market volatility from time-to-time, impacting corporate credit more than munis,” they said. “We believe a likely scenario for relative taxable muni/corporate performance should mimic 2018’s behavior.”
What to expect from the FOMC
The Federal Open Market Committee clearly delineated what it will do, the only question ahead of its meeting next week is the timing.
Indeed, analysts expect the January 25-26, or the minutes of the meeting which will be released three weeks later, will offer more clues in terms of the pace of timing of rate hikes and balance sheet reduction plans.
The meeting “should give some clarity on the Central Banks plans,” said John Farawell, managing director and head of municipal trading at Roosevelt & Cross. “How many rate hikes do they expect or future tapering expectations.”
Dealing with “inflation, tight labor markets, supply chain issues and the Omicron variant will test the Fed,” he said. “This new paradigm also has the challenge of raising rates without putting the economy towards a recession.”
How Treasury yields move after the meeting “will give us an insight on the market's opinion of inflation and the Fed's ability to control it,” Farawell said.
The meeting will “set the stage for a March rate hike,” said Luigi Speranza, chief global economist at BNP Paribas Markets 360, and offer details “on the ongoing debate over quantitative tightening (QT).”
BNP expects four rate increases, beginning with a March liftoff, and a QT announcement in July. “Risks are for an even earlier start to the QT process,” he said.
Given the Fed’s desire to end tapering before raising rates, Gary Pzegeo, head of fixed income at CIBC Private Wealth U.S., said, “we don’t expect a policy move at the January meeting.”
A hike at this point, he said, “would be too soon based on the current glide path for asset purchases. The January meeting will probably include further discussion around the timing and magnitude of quantitative tightening and additional messaging around timing for the first rate hike.”
Morgan Stanley Researchers see the FOMC signaling a March liftoff, the first of four hikes in the year, while in his post-meeting press conference Fed Chair Jerome “Powell avoids committing to a pace of tightening by stressing that every meeting is live and delivers additional details on QT as those discussions progress.”
In July, they expect the FOMC will announce “a more aggressive runoff of its balance sheet.”
Expect “a quieter affair” than the December meeting but still an attention grabber, said Wells Fargo Securities Chief Economist Jay Bryson, Senior Economist Sarah House and Economist Michael Pugliese. “Although we do not expect any policy changes, there will still be plenty to unpack.”
First on the list is inflation, which “has gotten further offsides,” they said. “We look for January's post-meeting statement to signal the fed funds rate could be lifted at its next meeting on March 15-16. Such a hint could come by indicating that the labor market is close to maximum employment, the remaining criteria the Committee has laid out for liftoff. We expect the statement and Chair Powell in his press conference to downplay the temporary slowdown in growth due to the most recent wave of the virus and highlight the overall strength of the labor market.”
Before the FOMC blackout, several Fed officials said they’d be willing to liftoff in March and “markets are primed for a hike, pricing in a probability of roughly 90%,” Bryson, House and Pugliese said. Unless there’s “an abrupt slowdown in inflation,” they said, the FOMC will hike in March despite an Omicron-related “stumble” in the labor market.
The Wells economists expect a 25-basis-point rate hike each quarter through the third quarter of 2023, with balance sheet reduction announced in September and starting a month later.
“Market expectations for rate hikes seem to be getting ahead of themselves,” said Subadra Rajappa, Societe Generale head of U.S. rates strategy. “While central banks are keen to rein in inflation, they are likely to adopt a measured approach.”
While the economy gradually recovers, the Fed will keep policy accommodative, Rajappa said. “The Fed is likely to push back on market pricing of more than four hikes for 2022 as it prepares to embark on a rapid pace of balance-sheet runoffs in 2H.”
The futures market is pricing in 4.2 rate hikes this year, with a March liftoff 96% priced in, noted Luke Tilley, chief economist at Wilmington Trust. “We expect two or three hikes this year,” with a pause until 2023 after a second hike in June, and balance sheet reduction “two to three meetings” after liftoff.
“The pause may seem counterintuitive,” he said, “as we have long expected rate hikes to proceed at a steady 25 bps per quarter once commenced. But that has been complicated by the likelihood of the Fed taking action to reduce their balance sheet in 2022.”
The possibility of inflation surprising to the downside later in the year exists, Tilley said, and could itself lead the Fed to pause.
“The prospect of reducing the Fed’s balance sheet in 2022 represents an even more substantial change to the outlook,” he said. Although it had been speculated about, the minutes from the December FOMC meeting “brought the issue to the fore” and “made it clear that the committee is mostly in agreement that balance sheet reduction should come after rate hikes commence, but the time between the two actions could be much shorter than the near-two years that elapsed in the previous cycle.”
Commercial bank loan growth has accelerated, Tilley said, with the fourth quarter rate the highest in a decade, when discounting the influence of the PPP program in 2020. “We think that pickup in loan growth has the FOMC’s attention, as strong loan growth could lead to the flow of excess bank reserves (currently held by commercial banks in their accounts with the Fed) into the economy and possibly fuel longer-term inflation,” he said. “Any macro textbook will tell you there is a money multiplier effect as those reserves move from the monetary base into the money supply.”
Given the consequences of the last quantitative tightening, Sebastien Galy, senior macro strategist at Nordea Asset Management, said, “the Fed this time will be far more prudent about quantitative tightening especially given high leverage in the system.”
The Leading Economic Index grew 0.8% in December after increasing 0.7% each of the two previous months, The Conference Board said Friday. The coincident index rose 0.2% and the lagging index climbed 0.2%.
The numbers suggest “the economy will continue to expand well into the spring,” said Ataman Ozyildirim, senior director of economic research at The Conference Board. “For the first quarter, headwinds from the Omicron variant, labor shortages, and inflationary pressures — as well as the Federal Reserve’s expected interest rate hikes — may moderate economic growth.”
The think tank sees 2.2% annualized GDP growth in the first quarter and expects 3.5% growth for the year.
Secondary trading
Ohio 5s of 2023 at 0.5%. DASNY 5s of 2023 at 0.5%. Charlotte, North Carolina 4s of 2024 at 0.68%. Loudoun County, Virginia 5s of 2024 at 0.79%-0.77%. Texas waters 5s of 2025 at 0.84%.
Monmouth County, New Jersey 5s of 2026 at 0.96%. California 5s of 2027 at 1.10%. Delaware 5s of 2029 at 1.16%.
New York City Municipal Water Finance Authority 5s of 2032 at 1.49%. Maryland 5s of 2034 at 1.42%. Los Angeles Department of Water and Power 5s of 2035 at 1.49%.
Los Angeles Department of Water and Power 5s of 2038 at 1.62%. Washington 5s of 2041 at 1.70%. California 5s of 2041 at 1.70%, the same as Thursday.
New York City Municipal Water Finance Authority 5s of 2044 at 1.97%. Ohio Water Development Authority green 5s of 2046 at 1.74%. New York City 5s of 2047 at 1.99%-1.90% versus 2.02% Wednesday.
AAA scales
Refinitiv MMD's scale was largely unchanged at the 3 p.m. read: the one-year steady at 0.39% and 0.58% (+2) in two years. The 10-year at 1.28% and the 30-year at 1.72%.
The ICE municipal yield curve was cut one to four basis points: 0.37% (+2) in 2023 and 0.62% (+4) in 2024. The 10-year was at 1.32% (+2) and the 30-year yield was at 1.73% (+1) in a 4 p.m. read.
The IHS Markit municipal analytics curve was cut one to two basis points: 0.40% (+2) in 2023 and 0.56% (+2) in 2024. The 10-year at 1.27% (+1) and the 30-year at 1.74% (unch) as of a 4 p.m. read.
Bloomberg BVAL was cut one to two basis points: 0.42% (+1) in 2023 and 0.57% (+1) in 2024. The 10-year cut one to 1.30% and the 30-year steady at 1.72% at a 4 p.m. read.
Treasuries were stronger and equities plummeted.
The two-year UST was yielding 1.006%, the five-year was yielding 1.560%, the 10-year yielding 1.761%, the 20-year at 2.148% and the 30-year Treasury was yielding 2.079%, at the close. The Dow Jones Industrial Average lost 450 points or 1.30%, the S&P was down 1.89% while the Nasdaq lost 2.72%, at the close.
Primary to come
Brightline West Passenger Rail Project (Aaa///) is set to price Thursday $894.3 million, Series 2020A, consisting of $774.3 million of Series 1 and $150 million of Series 2. Morgan Stanley & Co.
The Airport Commission of the City and County of San Francisco at the San Francisco International Airport (A1//A+/) is set to price Tuesday $749.155 million of second series revenue bonds, consisting of $308.73 million of alternative minimum tax bonds, Series 2022A, serials 2024-2032 and 2052; $239.23 million of non-alternative minimum tax bonds, Series 2022B, serials 2026-2030 and 2052; and $201.195 million of federally taxable bonds, Series 2022C, serials 2030-2032 and 2034-2037. Citigroup Global Markets.
The Black Belt Energy Gas District (Baa1//A-/) is on the day-to-day calendar with $498.92 million of gas project revenue bonds (Project No. 8), 2022 SERIES A. Goldman Sachs & Co.
The Connecticut Health And Educational Facilities Authority (Aaa/AAA///) is set to price Tuesday $400 million of Yale University Issue revenue bonds, consisting of $125 million of Series U-1, $125 million of Series U-2 and $150 million of Series A-4. J.P. Morgan Securities.
Austin Independent School District, Texas (Aaa///) is set to price Wednesday $221.985 million, consisting of $92.87 million of unlimited tax school building bonds, Series 2022A, serials 2022-2041, insured by Permanent School Fund Guarantee Program; $100.395 million of unlimited tax refunding bonds, Series 2022B, serials 2027-2036, insured by Permanent School Fund Guarantee Program; and $28.72 million of unlimited tax refunding bonds, Series 2022C, serials 2028-2033. Ramirez & Co.
Austin Independent School District, Texas (Aaa///) is also set to price Tuesday $129.815 million of taxable unlimited tax refunding bonds, consisting of $50.27 million, Series 2022D, serials 2026-2035, insured by Permanent School Fund Guarantee Program and $79.545 million, Series 2022E, serials 2025-2031. Ramirez & Co.
The Ohio Housing Finance Agency (Aaa////) is set to price Thursday $175 million of social non-alternative minimum tax residential mortgage revenue bonds, 2022 Series A, serials 2022-2033, terms 2037, 2042, 2047, 2052 and 2052. Citigroup Global Markets.
Forney Independent School District, Texas Thursday (/AAA//) is set to price $152.585 million of unlimited tax school building bonds, Series 2022A, insured by Permanent School Fund Guarantee Program. FHN Financial Capital Markets.
Alvin Independent School District, Texas (Aaa//AAA/) is set to price Wednesday $117.39 million of unlimited tax schoolhouse bonds, Series 2022, insured by Permanent School Fund Guarantee Program. Piper Sandler & Co.
Palacios Independent School District, Texas (Aaa///) is set to price Tuesday $116.5 million of unlimited tax school building bonds, Series 2022, serials 2023-2042, terms 2045, 2047, 2049 and 2051, insured by Permanent School Fund Guarantee Program. HilltopSecurities.
The Charlotte-Mecklenburg Hospital Authority, North Carolina (Aa3/AA-///) is set to price Wednesday $115.335 million of health care refunding revenue bonds, Series 2022A, serials 2023-2043, Citigroup Global Markets.
The California Statewide Communities Development Authority Community Improvement Authority is set to price Tuesday $113.965 million of essential housing revenue bonds, consisting of $11 million of Series A-1, serial 2043; $73.99 million of Series A-2, serial 2058; and $28.975 million of Series B, serial 2058. Stifel, Nicolaus & Co.
Competitive:
Worcester, Massachusetts (//AA/) is set to sell $208.01 million of general obligation municipal purpose loan of 2022 bonds at Monday noon eastern.
Spartanbury County School District #5, South Carolina (Aa2/AA-//) is set to sell $100 million of general obligation bonds, Series 2022 at Thursday 11 a.m. eastern.
