Munis outperform UST rout, but damage felt across the curve

Bonds

Municipals sold off Friday with the front end of the curve being hit the hardest, though damage was felt across the curve. Triple-A benchmarks outperformed a U.S. Treasury rout where yields rose double-digits, and equities were down near the close.

Nearly all triple-A benchmark yields were cut six to 10 basis points and UST yields rose 15 to 21 basis points 10 years and in.

“The latest batch of robust economic data, ranging from stronger-than-expected durable goods, factory orders, and of course today’s very strong payrolls, as well as more warnings from Federal Reserve officials against a potential pivot that some market participants have started to expect in the past several weeks, has put some pressure on Treasuries,” said Barclays strategists Mikhail Foux, Clare Pickering and Mayur Patel.

In response to the data, the UST yield curve has “continued to flatten, with the front end underperforming the most, and the 2s10s UST curve inverting even further,” they said.

Muni-UST ratios continue to fluctuate as a result of these less-cohesive movements between the asset classes. Ratios on Friday were at 61% in five years, 79% in 10 years and 95% in 30 years, according to Refinitiv MMD’s 3 p.m. read. ICE Data Services had the five at 61%, the 10 at 82% and the 30 at 94% at a 3:30 p.m. read.

Over the past several weeks, tax-exempts have been outperforming Treasuries in the selloff, as muni market technicals have dramatically improved, Barclays strategists said. 

“Large fund outflows have stopped (there was actually a sizable inflow this week), supply remains subdued (the past month was the lowest July’s issuance number in more than two decades), 30-day visible supply is still well below average, and, of course, investors will benefit from $40bn+ in redemptions in August, not counting $12bn in coupons,” they noted.

Currently, front-end ratios are extremely rich, while the belly of the curve is also on the richer side. Only the long-end is trading close to its fair value, they said.

For Foux, Pickering and Patel, “municipal valuations are completely unattractive at current levels — the muni market simply went too far, too fast in July and early August.”

“In our view, investors should lighten up going into September, and should look for a better entry point in the fall,” they said. “As before, we believe that Q4 22 will be a good return quarter for municipals.”

The 10-year Treasury yield went as low as 2.5143% on Tuesday, according to BofA strategists Yingchen Li and Ian Rogow. BofA’s rates group updated its view and forecasted the 10-year yield likely will fall to 2% in six to 12 months.

“Underlying this forecast is the belief that the market has not priced in the risk of a hard landing; although, at this point, the prevailing view on the economy is still a mild recession,” they said.

“Technically speaking, we are already in a mild recession due to the negative GDP prints for the last two consecutive quarters. Still, a strong jobs market has distinguished it from a normal recession. We expect the high grade muni rally to remain strong in August and credit spreads to be stable-to-slightly narrower,” according to Li and Rogow.

Primary to come
Investors will be greeted Monday with an increase in supply with the new-issue calendar estimated at $5.941 billion, up from total sales of $1.700 billion.

There are $4.513 billion of negotiated deals on tap and $1.428 billion on the competitive calendar.

The primary is led by the $991 million of Los Angeles International Airport refunding bonds from the Department of Airports of the City of Los Angeles followed by $400 million of general revenue bonds from the Triborough Bridge and Tunnel Authority, New York, and $340 million of GOs from Alameda County, California.

Fresh on the heels of an upgrade to Aaa from Moody’s Investors Service, Minnesota leads the competitive calendar with $591 million of GOs in five deals, followed by the Board of Education for the Nebo School District with $101 million of GOs.

Secondary trading
Maryland 5s of 2023 at 1.65%. Washington 5s of 2024 at 1.81%. Georgia 5s of 2025 at 1.70%. Prince George’s County, Maryland, 5s of 2027 at 1.80%.

Austin Water and Wastewater System, Texas, 5s of 2030 at 2.30% versus 2.25% Thursday and 2.29% Wednesday.

Metropolitan Government of Nashville and Davis County, Tennessee, 5s of 2037 at 2.86%-2.85% versus 2.87% on 7/26 and 2.92%-2.91% on 7/25.

Austin Water and Wastewater System, Texas, 5s of 2039 at 3.03%-3.07% versus 2.96% Monday. California 5s of 2042 at 2.90% versus 3.13%-3.11% on 7/18.

Salt Lake City Public Utilities, Utah, 5s at 3.20% versus 3.08% Wednesday and 3.14% on 7/28.

AAA scales
Refinitiv MMD’s scale was cut six to 10 basis points the 3 p.m. read: the one-year at 1.59% (+10) and 1.69% (+8) in two years. The five-year at 1.82% (+6), the 10-year at 2.24% (+6) and the 30-year at 2.91% (+6).

The ICE AAA yield curve was cut six to eight basis points: 1.62% (+8) in 2023 and 1.68% (+7) in 2024. The five-year at 1.83% (+7), the 10-year was at 2.28% (+6) and the 30-year yield was at 2.92% (+7) at 3:30 p.m.

The IHS Markit municipal curve was cut seven to 10 basis points: 1.56% (+10) in 2023 and 1.69% (+7) in 2024. The five-year was at 1.82% (+7), the 10-year was at 2.24% (+7) and the 30-year yield was at 2.92% (+7) at a 3 p.m. read.

Bloomberg BVAL saw cuts: 1.54% (+18) in 2023 and 1.65% (+7) in 2024. The five-year at 1.83% (+6), the 10-year at 2.25% (+6) and the 30-year at 2.91% (+7) at 3:30 p.m.

Treasuries were firmer in most spots near the close.

The two-year UST was yielding 3.251% (+21), the three-year was at 3.195% (+21), the five-year at 2.974% (+18), the seven-year 2.915% (+16), the 10-year yielding 2.834% (+15), the 20-year at 3271% (+12) and the 30-year Treasury was yielding 3.060% (+9) near the close.

July jobs report stuns
Following a massive July jobs report that showed a gain of 528,000 jobs — more than double of economists’ expectations — the U.S. economy has now recovered all of the jobs lost during the pandemic.

“The July nonfarm payroll report delivered a juicy plot twist in the Wall Street’s Fed pivot playbook,” said Edward Moya, senior market analyst at OANDA.

“Stubbornly high inflation and a global economic slowdown was expected to drag down the U.S. economy, but after today’s jobs report that does not seem to be the case,” he said. “Fed officials were already pushing back on the idea of a Fed pivot and now it seems they will be debating whether they need to be even more aggressive to tackle inflation given how strong the labor market is performing.”

“A powerful increase in July employment — at 528,000, the largest since last December —underscored bedrock support from the labor market, putting the economy on a more gradual trajectory for a recession,” said Wells Fargo Investment Institute global strategist Gary Schlossberg.

Marvin Loh, senior macro strategist at State Street Global Markets agreed, saying, “The strength of the report pushes against growing recessionary concerns, with the risk of a collapse in demand in total contrast to an economy that has added 1.3 million jobs over the past [three] months.

“Demand is certainly slowing but the strong labor market is an important buffer for consumer demand,” said Brian Coulton, chief economist at Fitch Ratings.

This means that “it may take some time and a lot of rate hikes to slow core inflation down,” he said.

“July payrolls surprised to the upside, reminding investors of how tight the labor market remains,” said Phillip Neuhart, director of market and economic research at First Citizens Bank Wealth Management. “The strong jobs market gives the Fed the latitude to aggressively tighten monetary policy and, at the same time, contributes to the need for tighter monetary policy.”

Wells Fargo Securities senior economist Sarah House and economist Michael Pugliese pointed out the “white-hot payroll numbers look increasingly out-of-line with other data points,” as the economic data currently are sending mixed messages.

“That said, employment growth of more than half a million jobs per month and a falling unemployment rate are hard to ignore,” they said.

The Payden & Rygel economics team, though, “still doubt[s] whether job growth can hold up near the current pace: 437,000 on average over the last three months.

Additionally, details from the nonfarm payrolls twin survey and the household survey show weakness.

The household survey rebounded to positive 179,000 in July, but household employment has been in negative territory in two of the last four months averaging negative 168,000 month over that period, the economics team said. Moreover, “the labor force participation rate ticked down in July, explaining some of the decline in the unemployment rate, which is not a sign of strength,” according to the team.  

“Concerns aside, we must admit that nonfarm payrolls are not flashing signs of a recession,” the team said. “The boom continues.”

However, for policymakers, “the surprising strength in nonfarm payroll employment in July suggests monetary policy tightening thus far hasn’t been nearly enough to curtail demand and, therefore, price pressures,” according to the team. “As a result, expectations for a Fed pivot were probably premature.”

“Tight labor-market conditions and a resulting buildup of wage pressures last month put to rest, for now, talk of an early pivot by the Federal Reserve away from credit tightening,” Schlossberg said.

House and Pugliese expect the data will give the Federal Open Market Committee “the confidence it needs to push ahead aggressively with its fight against inflation.”

At the September meeting, they said at least a 50 basis point seems likely, and yet another 75 basis point hike could happen if inflation over the next two consumer price index reports shows no signs of trending lower.

“Odds now favor the 75 basis-point increase in the Federal Reserve’s target rate (to 3%-3.25%) that we have been expecting at the September 20-21 policy meeting,” Schlossberg said.

Mickey Levy and Mahmoud Abu Ghzalah of Berenberg Capital Markets concurred, saying, “Robust payrolls growth and an intensification in wage pressures raise the odds of a third consecutive 75bp rate hike in September.”

“Equally important is whether we will get the moderation in data that will allow it to slow its pace of hikes after September,” Loh said.

“Since we theoretically reached the neutral rate last month, any additional hikes pushes us further into restrictive territory,” he said. “For the moment, the Fed has been affirming its June view that terminal of about 3.75% was appropriate, with the market only slightly discounting that view after today’s report.”

But “whether this outlook proves correct will come into focus this fall, when inflation is expected to aggressively start to moderate on base effects and slowing demand,” he noted.

“If that does not happen, the resolve of the Fed to keep pushing will be tested, as other data has started to show slowing in various parts of the economy, although arguably the jobs market remains the most important data point, and we have yet to see any relief on tight labor markets,” Loh said.

New-issue calendar:
The Department of Airports of the City of Los Angeles, California, (Aa2/AA/AA/) is set to price Tuesday $990.680 million of Los Angeles International Airport refunding bonds, consisting of $602.885 million of Series 2022G, $178.570 million of Series 2022H and $209.225 million of Series 2022I. Goldman Sachs & Co.

The Triborough Bridge and Tunnel Authority, New York, (Aa3/AA-/AA-/AA/) is set to price Thursday $400 million of general revenue bonds, Series 2022A. Morgan Stanley & Co.

Alameda County, California, (Aaa/AAA/AAA/) is set to price Tuesday $340 million of taxable Measure A1 general obligation social bonds, 2022 Series B, serials 2023-2037, term 2042. UBS Financial Services.

Philadelphia, Pennsylvania, (A1/A+/A+/) is set to price Tuesday $307.375 million of water and wastewater revenue bonds, Series 2022C, serials 2023-2042, terms 2047 and 2052. RBC Capital Markets.

Cook County, Illinois, (A2/A+/AA-/) is set to price Thursday $279.805 million, consisting of $270.620 million of general obligation refunding bonds, Series 2022A, serials 2022-2029 and 2033 and $9.185 million of taxable general obligation refunding bonds, Series 2022B, serials 2022-2025, 2029 and 2033. Barclays Capital.

The countyis also set to price Tuesday $215.475 million, consisting of $156.575 million of sales tax revenue bonds, Series 2022A and $58.900 million of sales tax revenue bonds, Refunding Series 2022B (/AA-//AAA). Morgan Stanley & Co.

San Antonio, Texas, (Aaa/AAA/AA+/) is set to price Tuesday $185.835 million, consisting of $57.880 million of general improvement bonds, Series 2022, serials 2023-2042; $80.110 million of combination tax and revenue certificates of obligation, Series 2022, serials 2023-2042 and $47.845 million of tax notes, Series 2022, serials 2023-2024. Siebert Williams Shank & Co.

The Hays Consolidated Independent School District, Texas, (Aaa//AAA/) is set to price Thursday $182.230 million of unlimited tax school building bonds, Series 2022, insured by the Permanent School Fund Guarantee Program. FHN Financial Capital Markets.

The Aubrey Independent School District, Texas, (Aaa/AAA//) is set to price Tuesday $180.380 million of unlimited tax school building bonds, Series 2022, serials 2027-2052, , insured by the Permanent School Fund Guarantee Program. Raymond James & Associates.

The Northshore School District No. 417, Washington, (Aaa///) is set to price Tuesday $152.790 million of unlimited tax general obligation and refunding bonds, Series 2022, insured by the Washington State School District Enhancement Program. Piper Sandler & Co. 

The Sarasota County Public Hospital District, Florida, (A1//AA-/) is set to price Thursday $150 million of Sarasota Memorial Hospital Project fixed rate hospital revenue bonds, Series 2022. J.P. Morgan Securities.

The Pasadena Independent School District, Texas, is set to price Tuesday $121.515 million of unlimited tax school building bonds, Series 2022. Piper Sandler & Co.

The Lehigh County Industrial Development Authority, Pennsylvania, (A1/A+//) is set to price Thursday $115.500 million of non-AMT PPL Electric Utilities Corporation Project pollution control revenue refunding bonds, Series 2016. Morgan Stanley & Co. 

The authority (A1/A+//) also is set to price Thursday $108.250 million of non-AMT PPL Electric Utilities Corporation Project pollution control revenue refunding bonds, Series 2016B. Morgan Stanley & Co.

San Antonio, Texas, (Aaa/AAA/AA+/) is set to price Tuesday $100.565 million of general improvement bonds, taxable Series 2022, serials 2023-2037, term 2042. Siebert Williams Shank & Co.

Competitive:
Minnesota (Aaa/AAA//) is set to sell $9.510 million of general obligation taxable state various purpose bonds, Series 2022C taxable, at 12:15 p.m. eastern Tuesday.

The state (Aaa/AAA//) also is set to sell $107.595 million of general obligation state various purpose refunding bonds, Series 2022D, at 11:45 a.m. Tuesday.

Minnesota (Aaa/AAA//) is set to sell $124.815 million of general obligation state various purpose bonds, Series 2022A, Bidding Group 2, at 11:15 a.m. Tuesday as well.

Additionally, the state (Aaa/AAA//) is set to sell $129.350 million of general obligation state various purpose bonds, Series 2022A, Bidding group 1, at 10:45 a.m. Tuesday.

Minnesota (Aaa/AAA//) is set to sell $220 million of general obligation state trunk highway bonds, Series 2022B, at 10:15 a.m. Tuesday.

The Board of Education for the Nebo School District, Utah, is set to sell $101.230 million of general obligation school building and refunding bonds, Series 2022, at 11:30 a.m. Tuesday. 

Gabriel Rivera contributed to this report.

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