Bonds

Municipals were weaker Tuesday, while USTs saw yields rise and equities ended mixed after a hotter-than-expected consumer price index report showed inflation may take longer to combat, and require higher rates, than the Federal Reserve planned.

Triple-A benchmarks were cut one to six basis points, depending on the scale, while UST yields rose nine to 13 basis points five years and in, pushing the five-year UST above 4%.

The three-year muni-UST ratio was at 52%, the five-year at 53%, the 10-year at 60% and the 30-year at 87%, according to Refinitiv MMD’s 3 p.m. ET read. ICE Data Services had the three at 56%, the five at 56%, the 10 at 61% and the 30 at 88% at 4 p.m.

Positive fund flows are benefiting the municipal market, but the supply shortage is impairing it, according to Craig Brothers, head of fixed income and portfolio manager at Bel Air Investment Advisors.

“The muni market has been affected by a big change in flows,” Brothers said.

The current fund flow activity is providing strength to the market compared to last year’s $140 billion exodus, according to Brothers. 

While funds have boosted the market, volume has paled in comparison.

“The last six weeks have experienced a very light primary calendar, with net inflows into mutual funds,” he said, noting the supply-demand imbalance has allowed the muni market to become very rich relative to Treasury bonds. 

“The ratio of muni to Treasury is now between 56% and 61% for the first 10 years of the curve,” he said. “We have a large calendar this week — $7 billion — which will test muni demand at these rich levels,” he added.

“The very strong January employment report on Feb 2 has pushed up the 10-year Treasury by 30 basis points,” he said. “January CPI report will have a strong influence on the bond market for the rest of February,” he continued.

Brothers expects inflation to be more persistent and difficult to bring down to the Fed’s 2% target. 

“We are content to remain patient until the muni supply and economic strength bring yields up to a more attractive entry point,” Brothers said.

Munis “remain, for the most part, confused by opposing visions outlined by the Fed — higher rates and perhaps not enough economic weakness ahead — and market fundamentals where demand is very likely to exceed supply over the near term,” said Matt Fabian, a partner at Municipal Market Analytics.

That muni-UST “ratios now measure municipals as extremely rich did not change the municipal demand side, at least by much.”

Traditional mutual fund inflows remained positive for four out of the last five weeks despite faltering NAV performance and exchange-traded fund withdrawals.

“The latter may be a (weird) sign of strength as customers that had (inappropriately) allocated to, say, MUB as a cash alternative, now pull out their funds for a more permanent allocation,” he said.

Things are no better in the short-term market, he said, “where the 2a7 industry’s tiny size (down 80% since 2008) means its rates are being violently tossed by the relatively large flows in-and-out.”

Municipal money funds have lost 15% of their assets under management in the last three weeks, he said.

The SIFMA/SOFR ratio has “also been unpredictable enough — jumping from 41.1% to 82.2% in the last week alone — that long-term damage for related products may well be occurring,” according to Fabian.

He expects it is “becoming harder for bankers or brokers to talk issuers or investors into SIFMA-based products, to the medium-term detriment of related volatility, and thus the utility in analytic coverage (like ours) of SIFMA as a rates market.”

In the primary market Tuesday, Morgan Stanley & Co. held a one-day retail order period for $1.730 billion of tax-exempt general revenue bonds, 2023 Series BN, for the Regents of the University of California, Authority (Aa2/AA/AA/), with 5s of 5/2023 of 2.72%, 5s of 2028 at 2.19%, 5s of 2033 at 2.37%, 5s of 2038 at 3.10%, 5s of 2043 at 3.36% and 5s of 2044 at 3.39%, callable 5/15/2033.

Piper Sandler & Co. priced for the Prosper Independent School District, Texas, (Aaa//AAA/) $247.710 million of PSF-insured unlimited tax school building bonds, Series 2023, with 5s of 2/2024 at 2.81%, 5s of 2028 at 2.28%, 5s of 2033 at 2.44%, 5s of 2038 at 3.23%, 5s of 2043 at 3.45%, 4s of 2048 at 4.13% and 4s of 2053 at 4.20%, callable 2/15/2033.

Stifel, Nicolaus & Co. priced for Dallas (/AAA/AA/) $166.330 million of waterworks and sewer system revenue refunding bonds, Series 2023A, with 5s of 10/2024 at 2.73%, 5s of 2028 at 2.28%, 5s of 2033 at 2.47%, 5s of 2038 at 3.26%, 4s of 2043 at 3.97%, 5s of 2047 at 3.68% and 4s of 2052 at 4.16%, callable 10/1/2033.

In the competitive, the Washington Suburban Sanitary District, Maryland, (Aaa/AAA/AAA/) sold $318.545 million of consolidated public improvement bonds of 2023, to BofA Securities, with 5s of 6/2023 at 2.70%, 5s of 2028 at 2.20%, 5s of 2033 at 2.25%, 5s of 2038 at 3.10%, 4s of 2043 at 3.89%, 4s of 2048 at 4.10% and 4s of 2052 at 4.14%, callable 6/1/2033.

Secondary trading
Connecticut 5s of 2024 at 2.36%-2.61% versus 2.29% on 1/25. North Carolina 5s of 2024 at 2.77%. Utah 5s of 2025 at 2.41% versus 2.35% on 2/7.

NYC TFA 5s of 2029 at 2.43% versus 2.43% original on Thursday. Wisconsin 5s of 2030 at 2.26%-2.24%. DC 5s of 2031 at 2.26% versus 2.26%-2.22% on 2/8.

Washington 5s of 2033 at 2.48%. Maryland 5s of 2034 at 2.43%. California 5s of 2035 at 2.58%.

Triborough Bridge and Tunnel Authority 5s of 2047 at 3.80% versus 3.86% Thursday and 3.72% on 2/7. NY State Urban Development Corp. 5s of 2049 at 3.87%.

AAA scales
Refinitiv MMD’s scale was cut two to five basis points. The one-year was at 2.71% (+5) and 2.42% (+2) in two years. The five-year was at 2.14% (+2), the 10-year at 2.26% (+2) and the 30-year at 3.30% (+2) at 3 p.m.

The ICE AAA yield curve was cut one to six basis points: 2.79% (+6) in 2024 and 2.53% (+4) in 2025. The five-year was at 2.21% (+3), the 10-year was at 2.26% (+2) and the 30-year yield was at 3.34% (+1) at 4 p.m.

The IHS Markit municipal curve was cut up to five basis points: 2.70% (+5) in 2024 and 2.40% (unch) in 2025. The five-year was at 2.13% (unch), the 10-year was at 2.28% (unch) and the 30-year yield was at 3.30% (+2) at a 4 p.m. read.

Bloomberg BVAL was cut one to three basis points: 2.69% (+2) in 2024 and 2.40% (+2) in 2025. The five-year at 2.19% (+2), the 10-year at 2.31% (+2) and the 30-year at 3.34% (+2).

Treasuries sold off on the short end.

The two-year UST was yielding 4.628% (+10), the three-year was at 4.332% (+13), the five-year at 4.008% (+9), the seven-year at 3.897% (+7), the 10-year at 3.752% (+4), the 20-year at 3.924% (+1) and the 30-year Treasury was yielding 3.784% (+1) at 4 p.m.

CPI comes in hotter than expected
While consumer prices rose 0.5% in January, the annual increases continued their downward trend.

The headline increase “was notably higher than the disinflationary signals provided over the past few months,” said Marvin Loh, senior global macro strategist at State Street. “Energy costs, which posted falling prices in five of the past seven months were again higher in January on rising oil and natural gas prices.  Overall food costs are also proving stubborn, rising again for the first time in six months.”

“On a core basis, which is where the Fed and markets are increasingly focused, monthly prices were stable from last month at 0.4%, but were higher than the 0.3% recorded in October and November,” Loh said. “This pushes the annualized three-month average to 4.4%, higher than the 3.2% that was reported for 4Q:22 before recent revisions.”

While inflation did not reaccelerate, Loh noted, “the somewhat sticky nature across headline and core categories support the Fed’s consistent message that inflation may take longer to combat than the market had been expecting.”

This has caused expectations of a higher terminal rate and potentially restrictive rates for a longer period, he said. ”This is ultimately what the Fed expected, and we would expect tighter financial conditions to prevail going into the next FOMC meeting in March.”

“Markets were expecting (hoping, praying) to get further confirmation that a) peak is in and b) decline is at least steady, if not accelerating,” said Jan Szilagyi, CEO and co-founder of Toggle AI. “This is critical for the disinflationary narrative and any hope for Fed cuts this year. We got neither.”

But while core goods inflation slowed sharply, that was “not enough to deliver a decisive drop in overall core inflation,” said Brian Coulton, Fitch chief economist. “Rental prices are still rising sharply and the price of transportation services is accelerating really quickly.”

The numbers may be skewed by seasonal adjustment factor revisions and annual CPI weight updates, which “likely added slightly to the monthly increase in core inflation and near-term core inflation pressures,” said Mickey Levy, chief economist for Americas and Asia at Berenberg Capital Markets. 

Taken together, he said, details of the report “suggest that although disinflation has taken hold, the process is likely to be a bumpy ride.”

Since the report doesn’t indicate “worsening inflationary pressures” on an annual basis, Morgan Stanley Research strategists, “the Fed will see more evidence accumulating that inflation is decelerating despite a stronger than anticipated labor market.”

“It looks like the Fed is in for a war of attrition rather than a decisive battle against inflation,” said Sean Snaith, director of the Institute for Economic Forecasting at the University of Central Florida, with persistent inflation “in food, energy, transportation and shelter — all big shares of consumers’ monthly budgets.”

Inflation expectations could become a concern, he said. “The longer inflation persists, the more people are going to come to expect it. And that can be even more dangerous when expectations for higher prices become entrenched.”

“The strength of core inflation suggests that the Fed has a lot more work to do to bring inflation back to 2%,” said Maria Vassalou, co-chief investment officer of multi-asset solutions at Goldman Sachs Asset Management. “If retail sales also show strength tomorrow, the Fed may have to increase their funds rate target to 5.5% in order to tame inflation.”

Getting inflation down to the Fed’s 2% target, Berenberg’s Levy said, “will both take time and require the Fed to hold the policy rate at a higher level for longer,” as “disinflationary momentum in core goods is moderating and price pressures in the service sector remain elevated.”

The data “underscores the challenges faced by the Fed,” said Morning Consult Chief Economist John Leer. While inflation may have peaked, he said, it’s not showing signs of rapidly returning to 2%.

“Shelter’s contribution to inflation is likely to slow in the coming months, but there remain upside risks to durable goods prices,” Leer said. “Despite all of the challenges facing the U.S. consumer, demand remains too strong relative to supply,” he said. “The fight against inflation is far from over.”

Wells Fargo Securities Senior Economist Sarah House and Economist Michael Pugliese, agreed, “inflation is not going away quietly.”

“Inflation is still set to grind lower, but the process is likely to be bumpy and take time,” they said.

Despite “some directional improvement over the past couple of quarters, prices are still growing well-above the Fed’s 2% target, and the tight labor market suggests that there are still inflationary pressures that could forestall a full return to 2% inflation,” the Wells Fargo Securities economists said.

“Core inflation continues to track above the 0.2% month-on-month prints required to get annual inflation down to the 2% target over time, but at least the annual rate continues to slow,” said ING Chief International Economist James Knightley.

However, he remains “optimistic that inflation can get close to 2% late in 2023, largely through flat to lower prices for shelter and a squeeze on corporate profit margins.”

“The key takeaway is that the trend for modest easing in inflation is likely to continue,” said Bryce Doty, senior vice president at Sit Investment Associates. “We still expect the Fed to put rate increases on hold by their May meeting and be content to watch inflation continue to ratchet down over time.”

The Wells Fargo Securities economists continue to look for the FOMC to “raise the fed funds rate by another 25 bps at both the March and May meetings and to hold the target range at 5.00%-5.25% through the year’s end to ensure that high inflation will be quelled for good.”

The Morgan Stanley Research strategists expect the Fed “tightening path to be largely set through the May FOMC, with a 25bp hike at each of the upcoming meetings. Beyond May, however, “a slowing labor market and more moderate inflation outcomes should set the stage for a stop in the tightening cycle and an eventual first rate cut in December,” they said.

Primary to come:
The Regents of the University of California (Aa2/AA/AA/) is set to price Wednesday $2.128 billion of general revenue bonds, consisting of $1.732 billion of tax-exempt bonds, 2023 Series BN; $52.345 million of taxables, 2023 Series BO; and $344.380 million of variable rate demand notes, 2023 Series BP. Morgan Stanley & Co.

The Salt River Project Agricultural Improvement and Power District, Arizona, (Aa1/AA+//) is set to price Wednesday $500 million of Salt River Project electric system revenue bonds, 2023 Series A, serials 2029-2032 and 2043, terms 2047 and 2050. J.P. Morgan Securities.

The San Francisco City and County Airport Commission (A1//A+/) is set to price Wednesday for the San Francisco International Airport $456.185 million of second series revenue refunding bonds, consisting of $376.490 million of AMT bonds, Series 2023A, serials 2023-2030, 2033 and 2038, and $79.695 million of non-AMT/governmental purpose bonds, Series 2023B, serial 2043. BofA Securities.

The Lower Colorado River Authority (/A/A+/) is set to price Wednesday $433.415 million of transmission contract refunding revenue bonds (LCRA Transmission Services Corporation Project), Series 2023, serials 2024-2043, terms 2048 and 2053. RBC Capital Markets

The Tarrant County Hospital District, Texas, (Aa1//AA/AAA) is set to price Thursday $412.160 million of limited tax bonds, Series 2023, serials 2024-2043, terms 2048 and 2053. Siebert Williams Shank & Co.

The Houston Independent School District, Texas, (Aaa/AAA//) is set to price Wednesday $163.250 million of limited tax refunding bonds, consisting of $98.680 million of PSF-insured bonds, serials 2024-2038, and $64.570 million on non-PSF-insured bonds, serials 2027-2032. HilltopSecurities.

The California Pollution Control Financing Authority (Baa3//BBB/) is set to price Thursday $158.110 million of AMT water furnishing revenue bonds (Poseidon Resources (Channelside) LP Desalination Project), Series 2023. Morgan Stanley & Co.

Competitive:
The Bend-La Pine Administrative School District 1, Oregon, (Aa1///) is set to sell $100 million of GOs, Series 2023, at noon, Eastern, Wednesday.

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