Bonds

Municipals were firmer in spots Thursday while U.S. Treasuries made larger gains and equities rallied a day after markets digested the Fed’s decision to hold rates steady.

Municipals saw some strength emerge as the session progressed with yields falling a basis point or two inside of 20 years while U.S. Treasuries saw yields fall up to 10 basis points on the five year near the close.

Municipal bond mutual fund outflows returned as Refinitiv Lipper reported investors pulled $256.532 million for the week ending Wednesday following $460 million of inflows the week prior.

Bonds out for the bid are getting attention and new issues are selling well but a lot of investors still appear to be sitting out, said Howard Mackey, managing director at NW Financial in Hoboken, N.J.

“From what we are seeing it’s a quiet market,” he said. “Deals are getting done and I’ve seen high-grade spreads in the general market widen out.”

While trading picked up Thursday somewhat, Kim Olsan, senior vice president of municipal bond trading at FHN Financial, noted that the early post-FOMC rate skip did little to spur munis.

Those “holding out for wider yields or relative value” are frustrated due to an extremely tight muni range, but Olsan said “the reality is that supply has yet to materialize to force that change.”

Rather, she noted “the yield path this year has brought greater ratio advantages,” but maybe not to the degree that some investors prefer.

Muni-UST ratios in the five-, 10- and 30-year ranges “are at parity or a few percentage points above their 2023 averages,” she said.

The two-year muni-Treasury ratio Thursday was at 63%, the three-year at 66%, the five-year at 67%, the 10-year at 69% and the 30-year at 91%, according to Refinitiv MMD’s 3 p.m. read. ICE Data Services had the two-year at 63%, the three-year at 65%, the five-year at 64%, the 10-year at 68% and the 30-year at 91% at 4 p.m.

The attractive ratios between shorter-term Treasuries and the triple-A scales are attracting demand from separately managed accounts, though, due to the better after-tax returns, according to Mackey.

He said some of the quieter seasonal tone stems from the impact of the FOMC’s announcement on Wednesday to pause rate hikes.

“I think a lot of people are concerned that because there will be a pause it’s going to open the door for more rate hikes in the future,” he said. “Within their goal of rate increases, that could entail a few, if not a number of rate hikes, over the next several months,” he said.

“A lot of people expected it but the only area that was affected positively is the equity market,” Mackey added. 

Back on the municipal buy side, he said retail investors will be spending some of their summer reinvestment cash on Treasuries due to the after-tax rewards.

“There’s always cash to invest and money will be coming back into the municipal market, but there is no groundswell that we can see at this point,” Mackey said

Despite some apprehension, Olsan said “secondary selling remains elevated with [Federal Deposit Insurance Corp.] liquidations adding around $300 million par value to the daily count (with a corresponding widening of 20-25 basis points in the 2% coupon range due to growing float).

There was uniformity in spreads among the new issues Wednesday, she said.

Chesterfield Country, Virginia, sold GOs with 5s “due out to 17 years spread no wider than +8/MMD” and a sale of Richland County School District #2, South Carolina, (Aa1/AA) school bonds “drew all 5s with the widest spread in the maximum 2039 maturity at +13/AAA,” she said.

A common topic this month has been spread compression with supply below that of scheduled redemptions, she said. Bloomberg data shows the “issue/redeemed mismatch” is at a negative $30 billion, according to Olsan.

“Exaggerated deficits in the high-tax/low-supply state group will exacerbate tight bidding conditions,” she said.

In the primary market Thursday, BofA Securities priced for the Louisiana Stadium and Exposition District (A2//A/) $526.440 million of senior revenue bonds. The first tranche, $497.250 million of tax-exempts, Series 2023A, with 5s of 7/2030 at 3.10%, 5s of 2033 at 3.20%, 5s of 2038 at 3.84%, 5s of 2043 at 4.16%, 5s of 2048 at 4.32% and 5.25s of 2053 at 4.34%, callable 7/1/2033.

The second tranche, $29.190 million of taxables, Series 2023B, saw all bonds price at par: 5.38s of 7/2024, 5.165s of 2028 and 5.169s of 2030, noncall.

Citigroup Global Markets priced for the Florida Development Finance Corp. $120 million of AMT solid waste disposal revenue bonds, with 6.125s of 7/2032 with a mandatory tender date of 7/2026 at par.

Secondary trading
California 4s of 2024 at 3.07%. Washington 5s of 2025 at 3.01% versus 3.00% Wednesday and 3.01% on 6/6. DC 5s of 2026 at 2.86%.

NYC 5s of 2029 at 2.90% versus 2.99%-2.97% on 6/6. Maryland 5s of 2030 at 2.62%. North Carolina 5s of 2030 at 2.65%.

Georgia 5s of 2033 at 2.63% versus 2.65% Wednesday. Wisconsin 5s of 2034 at 2.74%-2.73% versus 2.86%-2.85% on 5/30. Triborough Bridge and Tunnel Authority 5s of 2034 at 2.80%-2.76%.

Washington 5s of 2048 at 3.71%. LA DWP 5s of 2049 at 3.63% versus 3.63%-3.65% Wednesday and 3.65%-3.55% Tuesday. Indiana Finance Authority 5s of 2053 at 4.10%-4.09% versus 4.14% Wednesday and 4.18%-4.14% Monday.

AAA scales
Refinitiv MMD’s scale was bumped up to two basis points: The one-year was at 3.07% (unch) and 2.93% (-2) in two years. The five-year was at 2.64% (-2), the 10-year at 2.57% (-2) and the 30-year at 3.50% (unch) at 3 p.m.

The ICE AAA yield curve was bumped up to two basis points: 3.10% (flat) in 2024 and 2.99% (-1) in 2025. The five-year was at 2.62% (-2), the 10-year was at 2.57% (-1) and the 30-year was at 3.54% (-1) at 4 p.m.

The IHS Markit municipal curve was bumped up to two basis points: 3.06% (unch) in 2024 and 2.93% (-2) in 2025. The five-year was at 2.64% (-2), the 10-year was at 2.56% (-2) and the 30-year yield was at 3.49% (unch), according to a 4 p.m. read.

Bloomberg BVAL was bumped up to two basis points: 3.02% (-1) in 2024 and 2.92% (-1) in 2025. The five-year at 2.62% (-1), the 10-year at 2.55% (-2) and the 30-year at 3.53% (-1) at 4 p.m.

Treasuries were firmer.

The two-year UST was yielding 4.638% (-7), the three-year was at 4.233% (-8), the five-year at 3.909% (-10), the 10-year at 3.716% (-8), the 20-year at 4.015% (-6) and the 30-year Treasury was yielding 3.839% (-4) at 4 p.m.

Mutual fund details
Refinitiv Lipper reported $256.532 million of outflows from municipal bond mutual fund outflows for the week that ended Wednesday following $459.867 million of inflows the week prior.

Exchange-traded muni funds reported outflows of $88.957 million after outflows of $131.858 million in the previous week. Ex-ETFs muni funds saw outflows of $167.575 million after inflows of $591.725 million in the prior week.

Long-term muni bond funds had inflows of 258.93 million in the latest week after inflows of $899.418 million in the previous week. Intermediate-term funds had $49.945 million of inflows after outflows of $9.947 million in the prior week.

National funds had outflows of $213.583 million after inflows of inflows of $390.555 million the previous week while high-yield muni funds reported outflows of $80.375 million after inflows of $379.630 million the week prior.

FOMC redux
The Federal Open Market Committee decided to hold steady and skip a rate hike at the conclusion of Wednesday’s meeting.

Thomas Urano, co-chief investment officer at Sage Advisory, said the “Fed took the appropriate step following the most aggressive tightening cycle since the late 1970s.”

Despite the pause, he said “quantitative tightening and Treasury supply will serve as additional policy tightening tools working in the background over the coming months.”

While anxiety exists within the market to see inflation fall quickly, Urano said “forcing disinflation while not cratering the economy takes patience.”

“A one-meeting pause makes little sense given the long lags involved with monetary policy,” said Padhraic Garvey, ING head of global debt and rates strategy.

“With the disinflationary trend set to accelerate, we see an extended pause,” he said.

However, while the feds fund rate remained unchanged between 5% to 5.25%, the updated dot plot suggests there will be more rate hikes this year. Rates could rise 50 basis points higher by the end of the year.

The Fed is exercising caution to keep the market prepared for the possibility of further hikes if needed, Urano said.

The “corresponding shift higher in the FOMC’s Summary of Economic Projections was an effective use of the forward guidance tool,” he said.

“The hawkish shift in the dots, particularly those for 2023, reflect the Fed’s acknowledgement that inflationary pressures are likely to persist for longer than previously expected,” said Mickey Levy and Mahmoud Abu Ghzalah of Berenberg Capital Markets.

These updated forecasts, they said, “suggest the Fed continues to expect it will need to maintain a significantly positive real federal funds rate (close to 2% across 2023-2024) to reduce inflation to 2%, a (belated) acknowledgement that we nonetheless applaud.

“The surge in the dot plot initially spooked the markets, but they settled down later due to [Fed] Chair Powell’s continued emphasis on data dependency, that further hikes are not assured and that major progress on inflation has been achieved,” said John Vail, chief global strategist at Nikko Asset Management.

If healthy spending throughout the summer continues, Edward Moya, senior market analyst for the Americas at OANDA, said “the Fed will need to deliver on that dot plot forecast that has penciled in two hikes.”

The Fed “is concerned that wage pressures will remain as the labor market remains very tight,” he said.

With the U.S. banking system continuing to be resilient and robust job gains, Moya said “the Fed needs to deliver more tightening and that is why the dot plots are pricing in two more small rate hikes.”

The Fed “kept optionality for the rest of the summer as the nine FOMC participants anticipate two more rate hikes,” he said.

However, there are “doubts that the Fed will deliver another 50 bps of tightening this year, and this is because the Fed’s expectation of additional tightening is premised on an inflation forecast that looks too high,” said Ryan Swift, U.S. bond strategist at BCA Research.

“We aren’t that far from the Fed’s end-2023 forecast already and further disinflationary pressures are likely to come through during the next six months,” he said.

“My main takeaway from [Wednesday’s] FOMC meeting is that the Fed is data dependent and not committed to delivering hikes shown in the median dot,” said Subadra Rajappa, head of U.S. rates strategy at Societe Generale.

The market, she said, “is barely pricing in a hike for this year, but the move up in the median dot has succeeded in getting the market to price out cuts for this year.”

The shift higher in the dot plot “squashes the idea of potential rate cuts this year but at the same time the Fed might not end up delivering the two additional rate hikes that are penciled in if growth and inflation slow as we expect,” said Angelo Kourkafas, senior investment strategist at Edward Jones.

Taking rate cuts off the table in 2023 “prevents the market from minimizing policy effectiveness by pricing away rate cut expectations,” Urano said.

Ultimately, he noted “the ‘high and hold’ policy approach remains key to executing a restrictive rate policy without overtightening.”

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