Municipals were mixed Thursday, but the selloff appeared to subside, just as muni mutual funds saw the largest outflows year-to-date. U.S. Treasuries rallied and equities ended down.
Outflows from municipal bond mutual funds intensified as Refinitiv Lipper reported $2.876 billion was pulled from them as of Wednesday after $255.794 million of outflows the week prior. The last time outflows topped $2 billion was the week ending January 4 when they hit $2.48 billion.
Selling has increased and yields have backed up in the municipal market, but ratios to Treasuries are still rich out to 15 years — due in part to the technical difference between the municipal and Treasury curves, noted Peter Delahunt, head of municipals at StoneX.
The two-year muni-Treasury ratio was at 61%, the three-year at 64%, the five-year at 65%, the 10-year at 67% and the 30-year at 91%, according to Refinitiv MMD’s 3 p.m. ET read. ICE Data Services had the two-year at 61%, three-year at 63%, the five-year at 62%, the 10-year at 66% and the 30-year at 91% at 4 p.m.
April offered subdued demand from principal and interest rollover reinvestments, but he said this will pick up as the market heads into the summer months.
Heavier bid-wanted activity became the norm this week, contributing to the cheaper bias in the municipal market, Jeff Lipton, head of municipal credit and market strategy and municipal capital markets at Oppenheimer & Co., said on Thursday.
“This week, munis became untethered from the Treasury market and sold off heavily against a backdrop of both primary and secondary volume pressure as well as capitulation to a nearly two-year low for relative value ratios given that overly rich valuations were simply unsustainable,” Lipton said.
By mid-day Thursday, the cuts along the front end of the curve for most AAA scales were much less pronounced as compared to the previous session, he noted.
Even though yields have moved to higher ground, he said even cheaper levels are needed to bring about more retail conviction.
But, he pointed out, timing is key as market technicals will soon shift as seasonal reinvestment needs take hold.
“At that time, we expect tax-exempts to regain some meaningful performance ground against taxables, even if issuance picks up on a more consistent basis following the May Federal Open Market Committee meeting,” he said.
For much of the week, secondary trading volume has been on the lighter side, with the more liquid names finding it challenging to catch a bid, according to Lipton.
“This week’s Fed-speak downplaying sharp recessionary fears and arguing for a continued fight against inflation served as background noise, but nevertheless added to the selling pressure in the bond market,” he said.
The evolving banking narrative gives the market comfort that a crisis has been averted, but there is still potential for further disruptions or even limited exits by certain players within the regional space, he noted.
With a number of key economic prints for March on the books, the early May FOMC meeting is now the primary focus, Lipton said.
“By expanding measures, the Fed’s tightening cycle seems to be yielding intended consequences, but understandably policymakers want more consistent evidence that inflation is target-bound,” he said. The markets are seeing real signs of moderating price pressure, particularly in some of the stickier areas, such as shelter expenses, he noted.
“If the data holds course and reveals further inflationary retrenchment, then there could be justification for a pause following what is likely to be a 25-basis point rate increase next month,” he said.
“While a number of policymakers are considering elevated prospects of recession, the general sentiment reflects a modest contraction as many economic indicators continue to point to a tight labor market and overall resiliency,” Lipton continued.
With respect to the banking disruptions, he said there have been some noted divergence among Central bankers over the potential impact upon credit extension and consumer activity, yet he believes that unless the economy shows heavy declines, the Fed will likely remain steady in its pursuit of a 2% inflation target.
At the same time, “unknown degrees of credit tightening would tend to take some time to work their way throughout the economic system, and for now it is difficult to advance prognostications for recessionary impact,” Lipton added.
In the primary market Thursday, Barclays Capital priced for the New Jersey Economic Development Authority (A2/A-/A/) $798.680 million of school facilities construction refunding bonds, 2023 Series RRR, with 5s of 3/2024 at 3.38%, 5s of 2028 at 3.10% and 5s of 2035 at 3.42%, callable 3/1/2033.
Barclays Capital also priced for the authority $283.440 million of forward-delivery school facilities construction refunding bonds, 2024 Series SSS, with 5s of 6/2024 at 4.01%, 5s of 2027 at 3.72%, 5s of 2033 at 3.86%, 5.25s of 2038 at 4.43% and 5.25s of 2039 at 4.50%, callable 6/15/2034.
NYC 5s of 2024 at 2.80% versus 2.42% on 4/12. Maryland 5s of 2024 at 3.18%-2.93%. California 5s of 2025 at 2.72%.
NY Dorm PIT 5s of 2028 at 2.60%-2.57%. North Carolina 5s of 2028 at 2.51%. Massachusetts 5s of 2029 at 2.43%-2.42% versus 2.10%-2.09% on 4/6.
New Mexico 5s of 2032 at 2.41%. Florida DOT 5s of 2033 at 2.46% versus 2.46% Wednesday. Oregon 5s of 2036 at 2.85% versus 2.90% Wednesday.
NYC TFA 5s of 2044 at 3.64% versus 3.42% on 4/12 and 3.40% on 4/6. Tampa waters, Florida, 5s of 2047 at 3.58%. San Jose Financing Authority, California, 5s of 2047 at 3.52%-3.50% versus 3.31% Monday and 3.24% on 4/6.
Refinitiv MMD’s scale was cut up to three basis points: The one-year was at 2.77% (+3) and 2.56% (+3) in two years. The five-year was at 2.36% (unch), the 10-year at 2.36% (unch) and the 30-year at 3.40% (unch) at 3 p.m.
The ICE AAA yield curve was changed up to two basis points: 2.83% (-2) in 2024 and 2.64% (-2) in 2025. The five-year was at 2.34% (+1), the 10-year was at 2.34% (+1) and the 30-year was at 3.43% (-1) at 4 p.m.
The IHS Markit municipal curve was cut up to three basis points: 2.75% (+3) in 2024 and 2.56% (+3) in 2025. The five-year was at 2.36% (+3), the 10-year was at 2.35% (unch) and the 30-year yield was at 3.40% (unch), according to a 4 p.m. read.
Bloomberg BVAL saw cuts on the front end of the curve: 2.67% (+3) in 2024 and 2.57% (+2) in 2025. The five-year at 2.30% (unch), the 10-year at 2.33% (unch) and the 30-year at 3.40% (unch) at 4 p.m.
Treasuries were firmer.
The two-year UST was yielding 4.159% (-10), the three-year was at 3.869% (-10), the five-year at 3.632% (-8), the seven-year at 3.585% (-7), the 10-year at 3.538% (-6), the 20-year at 3.870% (-4) and the 30-year Treasury was yielding 3.746% (-5) at 4 p.m.
Muni market performance update
“This year’s municipal performance has been exceptional, which we believe suggests that more compelling entry points may surface in the coming months,” said Morgan Stanley investment strategists Matthew Gastall and Daryl Helsing in a Morgan Stanley Wealth Management monthly report.
Conversely, other fixed-income instruments, though, “are now further functioning as effective complements that may — all together now — help investors achieve their objectives with targeted and defined interest payments,” they said.
Similar to the volatility experienced during 2008, the Taper Tantrum, the 2016 elections and the COVID-19 pandemic, the past 16 months “have been highly eventful throughout the financial markets,” they said.
Throughout this time period, “many bond markets have managed an important comeback — one that has centered on both fiscal and monetary policies, as well as our broader emergence from the COVID-19 pandemic,” Morgan Stanley strategists said.
While “we’ve still yet to return to the long-term historical averages for inflation, it does appear as if current central bank efforts have been successful, thus far,” they said.
Speaking to this progress, they noted that “success with moderating the phenomenon often provides bond investors with a sense of comfort that the future values, or purchasing powers, of their fixed coupon payments will be better preserved.”
They said “both economic and regulatory environments may continue to transition as a result of the banking developments that originally emanated from Silicon Valley.”
At a minimum, Morgan Stanley noted “the risks of a recession are now likely higher.”
“Whether or not this economic slowing occurs, even the expectations of such a development can encourage investors to fly-to-quality and add positions to perceived safe-haven instruments, which often include many classes of fixed income and, specifically, municipals,” they said.
This “may exude stronger short-term impacts on taxable fixed-income products,” they said.
Munis’ performance has been helped significantly by a supply/demand imbalance, according to Morgan Stanley strategists.
Therefore, munis “may not respond to exogenous developments as swiftly as more relatively attractive taxable investments may,” they said.
“Glancing first at the broader arenas and then transitioning to public finance, either a reversal in inflationary progress or an alleviation in economic anxieties could cause interest rates to rise once again,” they said. “Recent price momentum predicated upon SVB’s banking developments may also shift should the considerations abate, among many other factors.”
The muni market seems to be in “a very strong position as we stand at the precipice of the seasonal spring ‘supply push,'” they said.
Prior to the summer months, issuers look to access the primary market, they said, with “this seasonal period is often accompanied by weaker redemption-driven reinvestment demand, which suggests that investors should prepare for the possibility of another eventful spring.”
Recent ultra-short-end rates “have been appealing as the result of a handful of notable developments,” Morgan Stanley strategists said.
There is value in “this section of the yield curve, particularly for taxable instruments, but further stress that municipal levels may continue to decline swiftly due to the unwinding of three important dynamics,” they said.
This includes “the alleviation of tax-time selling stresses, short-term credit support (not underlying municipal entity) concerns for those provided by certain banks, and a higher short-end yield curve influenced by the current federal funds target rate,” they noted.
These dynamics, which are likely to correct themselves, are mostly technical in nature, they said.
Mutual fund details
Refinitiv Lipper reported $2.876 billion of municipal bond mutual fund outflows for the week that ended Wednesday following $255.794 million of outflows the previous week.
Exchange-traded muni funds reported outflows of $629.981 million after outflows of $136.145 million in the previous week. Ex-ETFs, muni funds saw outflows of $2.246 billion after outflows of $119.649 million in the prior week.
Long-term muni bond funds had outflows of $2.260 billion in the latest week after inflows of $223.768 million in the previous week. Intermediate-term funds had outflows of $45.626 million after outflows of $24.005 million in the prior week.
National funds had outflows of $2.820 billion after outflows of $187.385 million the previous week while high-yield muni funds reported outflows of $79.125 million after inflows of $197.574 million the week prior.