Munis weaker, mutual funds lose another $2.4B

Bonds

Municipals were weaker in secondary trading Thursday as a $1 billion-plus deal from the City and County of Denver took focus in the primary and mutual fund outflows grew by another $2.4 billion. U.S. Treasury yields rose, with the two-year seeing the greatest losses, and equities ended in the red as markets continue to digest Fed policy moves.

Triple-A yields rose two to four basis points while UST saw yields rise as much as nine basis points on the two-year to highs last reached in July 2007. The two-year UST is currently 53 basis points higher than the 30-year.

The days moves held muni to UST ratios to recent levels. The three-year muni-UST ratio was at 68%, the five-year at 74%, the 10-year at 81% and the 30-year at 98%, according to Refinitiv MMD’s 3 p.m. read. ICE Data Services had the three at 70%, the five at 74%, the 10 at 84% and the 30 at 100% at a 4 p.m. read.

Refinitiv Lipper reported $2.389 billion of outflows from municipal bond mutual funds for the week ending Wednesday after $1.798 billion the week prior.

High-yield saw outflows of $867.067 million after outflows of $594.497 million the week prior while exchange-traded funds saw inflows of $736.967 million after $444.544 million of inflows the previous week.

In the primary market Thursday, Barclays Capital priced for the City and County of Denver (Aa3/AA-/AA-/) for its Department of Aviation $1.163 billion of airport system revenue bonds. The first tranche, $349.360 million of fixed-rate non-AMT bonds, Series 20CC, saw 5s of 11/2023 at 3.22%, 5s of 2027 at 3.52%, 5s of 2032 at 3.72%, 5s of 2037 at 4.28%, 5.25s of 2042 at 4.55%, 5.25s of 2047 at 4.73% and 5.25s of 2052 at 4.85%, callable 11/15/2032.

The second tranche, $813.890 million of fixed-rate AMT bonds, Series 20CD, saw 5s of 11/2024 at 3.94%, 5.25s of 2027 at 4.20%, 5.5s of 2032 at 4.55%, 5.75s of 2037 at 4.85%, 5s of 2042 at 5.19%, 5.75s of 2045 at 5.07% and 5s of 2053 at 45.36%, callable 11/15/2032.

Barclays Capital priced for the Public Finance Authority, Wisconsin, (Baa2/AA//) $212.210 million of project revenue bonds (CFP3 – Eastern Michigan University Student Housing Project). The first tranche of $211.870 million of exempts, Series A-1, saw 5s of 7/2026 at 4.23%, 5s of 2027 at 4.28%, 5s of 2032 at 4.59%, 5.25s of 2037 at 5.06%, 5.25s of 2042 at 5.32%, 5.375s of 2047 at 5.51%, 5.5s of 2052 at 5.62% and 5.625s of 2055 at 5.72%, callable 7/1/2032.

The second tranche, $340,000 of taxables, Series A-2, saw 5.875s of 7/2025 price at par, noncall.

“Broader gains are being made in early November business as potential cash is forced into the secondary market for meaningful product,” said Kim Olsan, senior vice president of municipal bond trading at FHN Financial.

“Generic AAA benchmark names are finding order interest closer to implied AAA spots and upper/mid-AA credits are trading with smaller concessions to reference points,” she said.

Large-issue utility credits, she noted, such as “Aa1/AA+ Salt River AZ Power bonds can be reliable barometers of buyer confidence in current levels.”

“Intermediate maturities in the issue are trading with nominal spreads to AAAs, as compared to levels from May (during a large pullback) that reached +20/AAA,” she said.

“Whether or not further gains can be made will depend on how much weight municipal bidders place on UST moves — follow any weakness or defy it in light of moderating supply,” Olsan said.

If mutual fund flows are any indication, she said “the bias appears to be a wait-and-see approach with a trading band of a 3.25%-3.50% 10-year AAA and 4.00%-4.20% 30-year AAA.”

Per Refinitiv Lipper, the four-week moving muni fund flow average is negative $2.3 billion, versus the Investment Company Institute’s negative $4.5 billion, and Olsan said, “absolute yields have not continued to trade off on that data.”

“Rather, attractive cross-market muni rates (100% or greater relative value and 8% TEYs in long high grades) and modest supply conditions (and projections) appear to have switched up how, not why, investors are participating in the asset class,” she said.

Continued muni outflows have put general selling pressure on the market, said Craig Brandon, co-director of municipal investments at Eaton Vance.

“You’re starting to get toward the end of the year here, and you’re starting to get the feeling that people have done a lot of tax-loss swapping this year,” he said. “Usually, it’s something that happens in December, and you’ve pulled a lot of that forward.”

All of those factors lead to weakness in the market.

But on the other side, supply has been lower than expected for the year.

And due to the FOMC meeting this week and Veterans Day next Friday, supply is not anticipated to pick up any time soon, he said. Thanksgiving is just on the horizon, followed by the holiday season, all leading to more instances of less issuance.

That lower issuance could help support the market a little bit as “we have these other negative factors going into the end of the year,” Brandon said.

“I generally get the feeling that the market wants to turn the page and get to 2023,” he said. “2022 has been such a terrible year … what people are starting to do is set themselves up for what is going to happen in January.”

Coupon stacks are being impacted by recent macroeconomic factors and intra-market fundamentals, Olsan said.

Trade data from the Municipal Securities Rulemaking Board indicate “a growing share being traded in 4s at the expense of more costly 5s,” she said.

On Wednesday, 4s accounted “for 30% of all volume in $1 million or higher par values past 10 years, up from 19% in the prior session,” while 3s “account for about 20% of all trades in this range,” she noted.

She said that “any eventual softening in the economy and plateau in rate hikes” would favor 4s coupons outperforming 5s.

Informa: Money market munis see outflows
Tax-exempt municipal money market funds saw $2.21 billion of outflows the week ending Monday, bringing the total assets to $110.85 billion, according to the Money Fund Report, a publication of Informa Financial Intelligence.

The average seven-day simple yield for all tax-free and municipal money-market funds fell to 1.81%.

Taxable money-fund assets inflows of $28.31 billion to end the reporting week at $4.469 trillion of total net assets. The average seven-day simple yield for all taxable reporting funds rose to 2.77%.

Secondary trading
Texas 5s of 2023 at 3.18%-3.12%. NYC 5s of 2024 at 3.23%. California 4s of 2024 at 3.20%-3.19%. Maryland 5s of 2025 at 3.21%-3.10% versus 3.18% Wednesday.

Maryland 5s of 2028 at 3.26%. Columbus, Ohio, 5s of 2029 at 3.34% versus 3.35%-3.31% Tuesday. Harris County, Texas, 5s of 2030 at 3.48%-3.47%.

California 5s of 2035 at 3.79%-3.75%. New York Dorm PITs 5s of 2037 at 4.10%. New York City TFA 5s of 2039 4.19%-4.18%.

Washington 5s of 2047 at 4.47%-4.45% versus 4.31% Tuesday. NYC TFA 5s of 2051 at 4.71%-4.70%. University of California 5s of 2052 at 4.43%-4.39%.

AAA scales
Refinitiv MMD’s scale was cut three to four basis points: the one-year at 3.12% (+3) and 3.17% (+3) in two years. The five-year at 3.22% (+4), the 10-year at 3.36% (+4) and the 30-year at 4.08% (+4).

The ICE AAA yield curve was cut two to four basis points: 3.12% (+2) in 2023 and 3.17% (+3) in 2024. The five-year at 3.22% (+3), the 10-year was at 3.42% (+2) and the 30-year yield was at 4.18% (+4) at a 4 p.m. read.

The IHS Markit municipal curve was cut four basis points: 3.12% (+4) in 2023 and 3.18% (+4) in 2024. The five-year was at 3.23% (+4), the 10-year was at 3.35% (+4) and the 30-year yield was at 4.07% (+4) at a 4 p.m. read.

Bloomberg BVAL was cut two to four basis points: 3.09% (+2) in 2023 and 3.15% (+2) in 2024. The five-year at 3.20% (+2), the 10-year at 3.35% (+4) and the 30-year at 4.08% (+3) at 4 p.m.

Treasuries were weaker.

The two-year UST was yielding 4.710% (+9), the three-year was at 4.638% (+7), the five-year at 4.364% (+5), the seven-year 4.267% (+5), the 10-year yielding 4.147% (+5), the 20-year at 4.453% (+2) and the 30-year Treasury was yielding 4.185% (+5) at the close.

FOMC redux
Market participants continue to digest another Federal Reserve Open Market Committee 75 basis point rate hike and its impact on broader markets.

“Given the historically fast progress the Fed has made in lifting the policy rate, Chair [Jerome] Powell in his press conference emphasized that ‘the important question’ is not how quickly the Fed will need to raise rates over the next few meetings, but rather where rates will need to end up and how long they will need to remain elevated,” said Mickey Levy and Mahmoud Abu Ghzalah of Berenberg Capital Markets.

Historically, they noted, “the Fed has always lifted the policy rate above inflation, and [Wednesday’s] outsized policy rate increase and commentary from Chair Powell indicating the terminal rate may need to rise above the Fed’s current dot-plot projection of 4.6% at year-end 2023 implies the real policy rate will move comfortably into positive territory early next year.”

“After initial hopes of a more dovish tone, it appears the remarks convinced the market of the Fed’s persistence to continue the current hiking cycle for now,” said Phil Rasori, COO of Mortgage Capital Trading.

“The Fed is likely to maintain its hawkish stance well into 2023, until recessionary conditions or financial stability concerns emerge,” Levy and Ghzalah said.

And while recession risks are rising, James Knightley, ING’s Chief International Economist, said “that is the price the Fed is prepared to pay to get inflation under control.”

Levy and Ghzalah predict the Fed “will step down the pace of rate hikes to 50bp at its December meeting, but also … lift rates by a further 50bp” during its first meeting in 2023, “which would lift the Fed funds rate target range to 4.75%-5.00%.”

They continue to anticipate “a mild recession will unfold over the course of 2023, which will prompt the Fed to ease policy toward the end of the year.”

Robert Bayston, head of U.S. Government and Mortgage Portfolios at Insight Investment, also expects “a smaller 50bp hike in December, representing a planned ‘downshift’ rather than a strategic ‘pivot’.” However, he noted “risks are skewed toward another 75bp hike, depending on upcoming data releases.”

“The Fed’s rate hikes have had more impact on financial assets this year than the real economy … reflected by tightening financial conditions over the year,” he said.

The upside is that tighter financial conditions, including higher rates, credit spreads and lower equity valuations, help the transmission of tighter monetary policy into the real economy, Bayston said.

“However, there is a danger that, as the Fed downshifts to a slower pace for tightening, the Fed will inadvertently loosen financial conditions if markets rally in the aftermath,” he said. 

The challenge for the Fed, Bayston said, is to communicate to the market “its desire to keep monetary policy and financial conditions tight over the medium term.”

“It may do this by continuing to deploy hawkish rhetoric,” he said. “Perhaps that is why Powell was clear to send a  message that the end of its hiking cycle is not yet in sight.”

He said “further bouts of market volatility appear highly likely as the Fed continues to manage market expectations.” 

Mutual fund details
Refinitiv Lipperon Thursday reported $2.389 billion of outflows for the week ending Wednesday following $1.798 billion the previous week.

Exchange-traded muni funds reported inflows of $736.967 million after inflows of $444.544 million in the previous week. Ex-ETFs, muni funds saw outflows of $3.126 billion after outflows of $2.243 billion in the prior week.

Long-term muni bond funds had outflows of $1.260 billion in the latest week after outflows of $1.211 billion in the previous week. Intermediate-term funds had outflows of $440.298 million after outflows of $296.872 million in the prior week.

National funds had outflows of $2.050 billion after outflows of $1.469 billion the previous week while high-yield muni funds reported outflows of $867.067 million after outflows of $594.497 million the week prior.

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