Weaker still, but slight outperformance to another swing in UST

Bonds

Municipals were weaker Monday, with yields rising two to five basis points, as U.S. Treasuries saw losses reversing Friday’s rally, while equities ended in the red on continued geopolitical tensions between Russia and Ukraine.

The municipal to UST ratio five-year was at 72%, 83% in 10 and 89% in 30, according to Refinitiv MMD’s 3 p.m. read. ICE Data Services had the five at 71%, the 10 at 84% and the 30 at 90% at a 4 p.m. read.

Municipal yields rose Friday and the weakness was still being felt Monday as the previous week’s $2.9 billion outflow signaled a drop in retail optimism, said Peter Block, managing director of credit strategy at Ramirez & Co.

“The pace and magnitude of fund flows will likely dictate muni performance from here,” he said. “Deals pricing earlier in the week had a better reception, with those pricing later in the week finding it more difficult to find buyers due to the selloff.”

Block said investor bids wanted in competition remained about double normal levels, highlighting the hangover from the previous week’s large fund outflows, despite trading throughput falling to 18% above average from 50% the week before due to the lower relative value of high grades. MMD Refinitiv saw average decreases of 18 basis points throughout the curve, with the 20-year at 1.87% and the 30-year at 2.03%.

“However, amidst the negative indicators, there has been selective buying,” said Pat Luby, CreditSights’ senior municipal strategist. “Net flows into municipal bond ETFs have been positive for the last two calendar weeks — although investors have been favoring low-duration strategies — and the total par amount of customer buy trades has continued to outweigh sell trades, although the net total was down from the prior.”

But while the net total decreased from the previous week, the total par amount of customer buy trades continue to outnumber sell trades, he said.

In the week ending Friday, Luby said customer buys outpaced sells by an average of $1.3 billion, down from $2.6 billion per day in the week ending Feb. 4. Net buys have outpaced selling by an average of $2 billion per day.

Further, he said while the current secondary market supply of variable rate demand notes is larger than the daily average from last year, it has decreased from the recent peak on Feb. 1.

Luby said the market is anticipated to underperform because of the dangers of an imbalance between muni demand and supply. While he predicts increased mutual fund outflows due to underperformance and volatility, he also expects taxable investment grade investors to demand tax-exempts if/when the relationship between tax-exempt muni yields and corporate yields is at least break-even or favors tax-exempts.

Last week, he said that link drew even closer — not near enough to signify imminent value, but close enough to warn taxable bond investors of the possibility of additional underperformance in the tax-exempt market.

“If this week’s new issues get priced at a concession to the market, there could be an opportunity for investment grade investors to add muni credit risk to their portfolios at yields that are comparable to corporate bond after-tax yields,” Luby said.

Tax-exempt yields are approaching parity with after-tax corporate bond yields, due to the underperformance of tax-exempts compared to corporates; additional underperformance might attract crossover buyers into the tax-exempt market, according to Luby.

He said investors will get $11.7 billion on Tuesday from bonds expiring or being called, which might increase demand this week. Taxable bonds will account for $1.3 billion of the total amount.

Principal payments are scheduled to reach $34.2 billion in February, $20.8 billion in March, and $15.4 billion in April. Redemptions will begin to rise in May, with $19.4 billion predicted, followed by $39.8 billion in June, which is likely to be the year’s highest monthly flows, he said.

Muni CUSIP volume drops
Monthly municipal volume declined in January but was still greater year-over-year. The aggregate total of all municipal securities, including municipal bonds, long-term and short-term notes, and commercial paper, fell 13.9% versus December totals.

For muni bonds specifically, there was a decrease in request volume of 14.2% month-over-month, but they are up 2.3% on a year-over-year basis.

“There is always some seasonality reflected in CUSIP request volumes for January, but when we look at the data over the long-term historical average, we’re seeing a strong start to 2022,” said Gerard Faulkner, direct of operations for CUSIP Global Services. “Right now, the bet on rising rates can be seen in year-over-year volumes for certificates of deposit. It will be interesting to see how this trend shapes up as the Fed prepares to raise interest rates.”

Secondary trading
New York City 5s of 2025 at 1.36%. California 5s of 2025 at 1.40%. Massachusetts Clean Water Trust 5s of 2026 at 1.41%.

New York City 5s of 2027 at 1.58%. North Carolina 5s of 2027 at 1.59% and 5s of 2029 at 1.64% Florida State Board of Education PECOs 5s of 2030 at 1.66%. California 5s of 2032 at 1.85%.

Washington 5s of 2045 at 2.15%. Los Angeles DPW at 2.29%.

AAA scales
Refinitiv MMD’s scale saw were cut up to four basis points at the 3 p.m. read: the one-year at 0.78% (unch) and 1.05% (unch) in two years. The five-year at 1.38% (+4), the 10-year at 1.65% (+4) and the 30-year at 2.03% (unch).

The ICE municipal yield curve saw cuts of two to five basis points: 0.83% (+5) in 2023 and 1.11% (+5) in 2024. The five-year at 1.37% (+5), the 10-year was at 1.69% (+4) and the 30-year yield was at 2.07% (+2) in a 3 p.m. read.

The IHS Markit municipal curve was cut: 0.77% (unch) in 2023 and 1.04% (+3) in 2024. The five-year at 1.39% (+4), the 10-year at 1.64% (+4) and the 30-year at 2.03% (unch) at a 3 p.m. read.

Bloomberg BVAL was cut two to three basis points: 0.82% (+2) in 2023 and 1.06% (+3) in 2024. The five-year at 1.40% (+3), the 10-year at 1.65% (+3) and the 30-year at 2.04% (+2) at a 4 p.m. read.

Treasuries were weaker while equities ended in the red.

The two-year UST was yielding 1.583%, the five-year was yielding 1.907%, the 10-year yielding 1.907%, and the 30-year Treasury was yielding 2.292% near the close. The Dow Jones Industrial Average lost 167 points or 0.35%, the S&P was down 0.35% while the Nasdaq was up 0.05% near the close.

Inflation still the topic
Inflation remains under market scrutiny, with Monday’s data suggesting consumers expect price pressures to cool later this year.

The January survey of consumer expectations showed respondents see inflation running at a 5.8% on a one-year horizon, down from 6.0% a month earlier, while inflation is expected at a 3.5% rate in three years, down from 4.0% last month, the Federal Reserve Bank of New York said.

Researchers found that consumers have changed their views on inflation, with some “short-term movements in inflation expected to persist into the future,” a New York Fed blog post said.

While the one-year expectations “are very responsive to inflation surprises,” as they were pre-pandemic, but “three-year-ahead inflation expectations are now far less responsive to inflation surprises than they were before the pandemic, indicating that consumers are taking less signal from the recent movements in inflation about inflation at longer horizons than they did before.”

But, economists now believe inflation will begin moderating in the last half of the year.

Jay Hatfield, chief investment officer at ICAP, pointed to energy and rent costs as indicators that inflation will remain elevated. “We continue to believe that the Fed will tighten monetary policy gradually in 2022 through four rate increases spread throughout the year and modest reduction in the balance sheet,” he said.

A San Francisco Fed Economic Letter suggests rent increases could add 0.5 points to inflation as measured by personal consumption expenditures in 2022 and 2023, which is “important to consider in light of the Federal Reserve’s 2% inflation target,” said the Bank’s Senior Research Advisor Kevin J. Lansing, Senior Associate Economist Luiz E. Oliveira and Vice President Adam Hale Shapiro.

While the market and other economists see more hikes this year, with expectations growing every day it sees, Hatfield noted, “President Biden will have appointed five of seven Federal Open Market Committee members when his nominees are approved, which implies a more dovish Fed.”

Additionally, monetary policy works with a lag, and financial conditions are already tightening in preparation for Fed action, he said. “In addition, the Fed has recently focused on its dual mandate of maintaining employment and moderate inflation vs. its prior sole focus on its ill-advised 2% inflation ceiling.”

Once the 10-year Treasury yield hits a bottom (somewhere around 2%), Hatfield said, equities will stabilize. “The current rate is 1.986% implying that we may be close to finding a stable level for long term rates,” he said.

The yield curve, Hatfield said, tends to flatten during tightening cycles.

KC Mathews, EVP/chief investment officer at UMB Bank, noted, “The slope of the yield curve now below 50 bps will trigger some conversations.”

In the current cycle, he said, things are “happening much sooner than any other historical experience,” pointing to the yield curve flattening “before the Fed even executed the first move.”

But, the bond market suggests a terminal rate around 2%-2.25%, and “the inflation story will abate by then and the curve will be flat,” Mathews said

“More moves in 2022 are certainly ,a fair consideration, but the bigger question is where it stops,” he continued. “In other words, we don’t believe the bond market is signaling an impending recession, but rather a soft landing after a fairly moderate tightening cycle.”

The proof, Mathews is the 10-year yield. “If the market thought inflation was going to run away and the Fed would be chasing it way above a 2.00% fed funds rate, why would the 10-year stay at 2.0%?” he asked. “We believe the 2-year is making room for a front-loaded set of moves from the Fed, at this time we are expecting four-five hikes, and the 10-year is telling us that the tightening cycle will end around 2.0%.”

Primary to come
University of Washington (Aaa/AA+//) is set to price Tuesday $400.855 million of general revenue bonds, consisting of $75 million, Series 2022A, serials 2023-2035 and 2037; $225.845 million of taxable refunding bonds, Series 2022B, serials 2022-2034, term 2041; and $100.01 million of term-rate refunding bonds, Series 2022C, serial 2048. Citigroup Global Markets.

Mount Nittany Medical Center, Pennsylvania, (/A+/AA-/) is set to price Tuesday $300 million of corporate CUSIP taxable revenue bonds, Series 2022. J.P. Morgan Securities.

Pennsylvania Housing Finance Agency (Aa1/AA+//) is set to price Wednesday $255.495 million of non-alternative minimum tax social single-family mortgage revenue bonds, Series 2022-138, serials 2022-2032, terms 2037, 2042, 2047 and 2052. Wells Fargo Bank.

Wisconsin (Aa1/AA+//AAA/) is set to price daily $236.975 million of taxable general obligation refunding bonds of 2022, Series 2, serials 2023-3032 and 2037. UBS Financial Services.

Waco Independent School District, Texas, is set to price Thursday $185 million of unlimited tax school building bonds, Series 2022. Oppenheimer & Co.

Peninsula Corridor Joint Powers Board, California, (/AA+//AAA) is set to price Tuesday $140 million of green climate-certified Measure RR sales tax revenue bonds, 2022 Series A. J.P. Morgan Securities.

Sanger Unified School District, California, is set to price Wednesday $105 million of 2022 certificate of participation. Stifel, Nicolaus & Co.

Georgetown Independent School District, Texas, (Aaa/AAA//) is set to price daily $103.88 million of taxable unlimited tax refunding bonds, Series 2022-A, insured by Permanent School Fund Guarantee Program. FHN Financial Capital Markets.

Northside Independent School District, Texas, (Aaa//AAA//) is set to price Tuesday $100.42 million of unlimited tax school building bonds, Series 2022A, insured by Permanent School Fund Guarantee Program. Morgan Stanley & Co.

Competitive:
Wake County, North Carolina, (Aaa/AAA/AAA/) is set to sell $42.215 million of general obligation parks, greenways, recreation and open space bonds, Series 2022C at 11:30 a.m. eastern Tuesday.

Wake County, North Carolina, (Aaa/AAA/AAA/) is set to sell $202.45 million of general obligation public improvement bonds, Series 2022A at 11 a.m. Tuesday.

Waco, Texas, (Aa1/AA+//) is set to sell $25.295 million of general obligation refunding bonds, Series 2022 at 11 a.m. Tuesday.

Waco, Texas, (Aa1/AA+//) is set to sell $103.22 million of combination tax and revenue certificates of obligation, Series 2022A at 11:30 a.m. Tuesday.

Delaware is set to sell $251.55 million of general obligation bonds, Series 2022 at 11 a.m. eastern Wednesday.

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