Bonds

Municipals were a little firmer in spots Tuesday, while equities and short-term U.S. Treasuries sold off after Federal Reserve Board Chair Jerome Powell suggested interest rates could be hiked higher than expected to combat inflation.

The two-year UST yield rose 13 basis points, pushing it above 5% for the first time since June 2007. The two-year UST is now a full point above the 10-year UST, something that hasn’t happened since August 1981.

The markets were shaken by Powell stating the terminal rate could be higher than the Fed previously thought and that rate increases larger than 25 basis points may be considered if the data indicates it would be appropriate. 

“There is little sign of disinflation thus far in the category of core services excluding housing, which accounts for more than half of core consumer expenditures,” Powell testified before the Senate Banking Committee. “To restore price stability, we will need to see lower inflation in this sector, and there will very likely be some softening in labor market conditions.”

As such, continued rate hikes, he said, “will be appropriate.”

Powell said the panel would be open to larger increases in the fed funds rate, if appropriate. “If the totality of the data were to indicate that faster tightening is warranted, we would be prepared to increase the pace of rate hikes,” he said. “Restoring price stability will likely require that we maintain a restrictive stance of monetary policy for some time.”

“Powell killed risk appetite with a hawkish first day on Capitol Hill,” said Edward Moya, senior market analyst for the Americas at OANDA. “Powell convinced markets that policymakers are comfortable taking this rate hiking campaign much higher. Powell is not taking any chances and wants to send home a clear message that the Fed will do whatever it takes to bring down inflation.”

“The Fed views strong data as more than just a blip,” said Berenberg Capital Markets Chief Economist for the U.S. Americas and Asia Mickey Levy, a member of the Shadow Open Market Committee. “While Powell acknowledged that some of the strength in January’s data was tied to unseasonably warm weather,” Levy said, Powell believes it “points to stronger inflationary momentum that would likely require a higher terminal rate than the Fed’s most recent projection of 5.1%” made in December.

The new dot plot will likely raise the “terminal rate projection by at least 25bp,” Levy said, “with risks tilted to the upside.”

“While we maintain our call for a 25bp rate hike in March,” Levy continued, “should data on employment and inflation released over the next two weeks surprise to the upside, the Fed would likely conclude it is once again falling behind the curve, and in response opt for a 50bp rate hike and a significant increase in the projected terminal rate.”

“Powell’s testimony shows that [the Fed’s] opinion has shifted again, with the strength in data suggesting the need for a higher ultimate policy rate and potentially faster rate hikes,” said ING Chief International Economist James Knightley. “Given long and varied lags [of monetary policy], the odds of a hard landing and an eventual policy reversal are rising.”

The chair “opened the door to a return of 50 bp hikes at the March meeting if the incoming data flow warrants it,” and perhaps at later meetings as well, Morgan Stanley analysts said. “Upside surprises to Friday’s payroll report could drive a faster and longer tightening cycle.”

The three-year muni-UST ratio was at 59%, the five-year at 62%, the 10-year at 66% and the 30-year at 92%, according to Refinitiv MMD’s 3 p.m. ET read. ICE Data Services had the three at 61%, the five at 62%, the 10 at 66% and the 30 at 92% at 4 p.m.

While interest rate volatility and fixed-income investment risk could make investors more defensive, the municipal market overall is fundamentally healthy, according to Jeff MacDonald, head of fixed income strategies at Fiduciary Trust International.

“Investor demand across the municipal market is being driven by concerns around inflation and potentially higher rates moving forward,” MacDonald said.

“Bearish sentiment with respect to rates seems to be the major near-term driver of market dynamics, which we expect to persist until more certainty evolves regarding the rate outlook,” he added.

Investors’ fears are impacting their buying choices, MacDonald said. For instance, rate and extension concerns have investors focused on higher coupon structures, he noted.  

“Selling has largely been focused on shorter maturities where the dollar impact of higher rates is more muted, but given the shape of the yield curve, buyers have shown more interest in maturities beyond 12 years where some curve steepness still exists and there is compensation for moving further out the yield curve,” MacDonald explained.

Demand for higher quality, liquid issuers, he said, remains high relative to other sectors, while areas vulnerable to inflation and wage and employment pressures, like healthcare, continue to demand higher yields from investors.

Investor concerns hurt the sale of new issues, according to MacDonald.

“Market participants’ uncertainty regarding the ultimate peak in interest rates has caused a number of primary market issues to struggle in coming to market,” he said. ”With investor anxiety running at a high level, market demand has been spotty, he continued.

While the limited supply — down over 28% year-to-date from last year—provides a tailwind for municipal performance, MacDonald believes the lack of investor support given the upward surprises in employment and inflation are the major drivers of recent market volatility.

“A number of deals in recent weeks have been postponed due to poor market conditions, while a defensive tone has led to a series of weekly outflows from fund investors,” he said.

Triple-A ratios continue to characterize the market as rich relative to the taxable market, he added, but actual trading activity paints a slightly different picture.  

“While not necessarily cheap relative to the taxable market, episodes of spread widening within credits suggest a market more fairly valued relative to risk-free taxable,” MacDonald said.

Municipal market investors’ key concerns in the current environment, meanwhile, will continue to be the ultimate direction of rates and the outlook for the health of the U.S. economy, he said.

“We expect market participants to remain focused on labor markets and inflation, which seem to be exhibiting some stickiness with respect to strength in the current environment,” MacDonald explained.  “Absent a reversal in the recent trajectory of these factors we expect to see an anxious investor base with spreads, volumes, and risk appetite playing defense against stronger data and a more hawkish, resolute Federal Reserve,” he added.

Unlike USTs, which with a 4% yield at the 10-year mark have begun to attract demand again,” munis are “less so, or at least not yet,” said Matt Fabian, a partner at Municipal Market Analytics.

He said, “customer demand has reflected smaller investors, institutional accounts appearing inclined to wait and see if outflows and thus losses continue.”

Mutual fund NAVs “had a terrible February and half of the funds tracked by MMA on a weekly basis are now at a [year-to-date] loss,” he said.

Also troubling is “continued volatility in the short-term market where wild swings in SIFMA reflect a mismatch in available assets (small) versus cash flows (large); the effect may be pushing lenders and borrowers into fixed rate alternatives,” he said.

Still, he said, there is “no net selling pressure; customer buying continues to outstrip selling on a daily basis, and bids wanted activity,” while elevated versus pre-2022 levels, is modest compared to averages since.

Fabian noted, “March reinvestment activity has not helped; the 30-day reading of bond calls and maturities” remains below 2021 and 2022 levels.

“This dims the value, a bit, of our market’s currently most constructive vector — scarcity — which continues to encourage opportunistic allocation all the same; tax-exempt issuance in January/February was $46.5B, down 15% from $54.5B last year,” he said.

Moreover, while the 30-day supply indicator was only average as of last week, this morning’s reading is a fair bit higher: too many bonds could accelerate things if losses resume this week.” Lastly, March has also been the worst month for price performance, he said.

In the primary market Tuesday, Goldman Sachs & Co. held a one-day retail order for $1.242 billion of water and sewer system second general resolution revenue bonds, Fiscal 2023 Series DD, for the New York City Municipal Water Finance Authority, with 5s of 6/2026 at 2.92%, 5s of 2028 at 2.79%, 5s of 2033 at 2.87%, 5s of 2038 at 3.66%, 5s of 2046 at 4.02%, 4.125s of 2047at 4.40% and 5.25s of 2047 at 3.98%, callable 6/15/2033.

RBC Capital Markets priced and repriced for the Board of Regents of the University of Texas System (Aaa/AAA/AAA/) $375 million of Permanent University Fund bonds, Series 2023A, with two to 10 basis point bumps: 5s of 7/2032 at 2.76% (-4), 5s of 2033 at 2.79% (-4), 5s of 7/2040 at 3.64% (-2), 4s of 2041 at 4.04% (-8), 5s of 2041 at 3.67% (-2) and 4.25s of 2052 at 4.27% (-10), callable 7/1/2033.

BofA Securities priced for the Pennsylvania Turnpike Commission (A3/A+/A/A+/) $345.535 million of turnpike subordinate revenue refunding bonds, First Series of 2023, with 5s of 12/2027 at 3.14%, 5s of 2028 at 3.14%, 5s of 2033 at 3.27%, 5s of 2038 at 3.93% and 5s of 2043 at 4.18%, callable 6/1/2033.

Secondary trading
NYC 5s of 2024 at 3.00%-2.95%. Alabama Public School and College Authority 5s of 2025 at 3.02%-3.00% versus 2.85%-2.84% on 2/16. Ohio 5s of 2026 at 2.85%-2.82%.

LA DWP 5s of 2027 at 2.63%. Minnesota 5s of 2027 at 2.75%-2.74%. Washington 5s of 2028 at 2.73%-2.72%.

Massachusetts Development Finance Authority 5s of 2032 at 2.49% versus 2.55% on 3/1. Huntsville, Alabama, 5s of 2035 at 2.98%.

Austin ISD, Texas, 4s of 2048 at 4.24%-4.23%. Gunter ISD, Texas, 5s of 2052 at 4.02% versus 3.80%-3.70% on 2/17.

AAA scales
Refinitiv MMD’s scale was bumped three basis points on the short end. The one-year was at 2.95% (-3) and 2.94% (-3) in two years. The five-year was at 2.66% (unch), the 10-year at 2.61% (unch) and the 30-year at 3.58% (unch) at 3 p.m.

The ICE AAA yield curve was bumped one to two basis points: 2.93% (-2) in 2024 and 2.92% (-2) in 2025. The five-year was at 2.66% (-2), the 10-year was at 2.64% (-1) and the 30-year yield was at 3.63% (-1) at 4 p.m.

The IHS Markit municipal curve was bumped three basis points at one- and two-years: 2.96% (-3) in 2024 and 2.94% (-3) in 2025. The five-year was at 2.64% (unch), the 10-year was at 2.60% (unch) and the 30-year yield was at 3.60% (unch) at a 4 p.m. read.

Bloomberg BVAL was bumped up to one basis point: 3.03% (-1) in 2024 and 2.93% (-1) in 2025. The five-year at 2.65% (unch), the 10-year at 2.64% (-1) and the 30-year at 3.60% (-1).

Treasuries were mixed.

The two-year UST was yielding 5.019% (+13), the three-year was at 4.725% (+11), the five-year at 4.319% (+6), the seven-year at 4.176% (+2), the 10-year at 3.972% (-1), the 20-year at 4.118% (-2) and the 30-year Treasury was yielding 3.881% (-4) at 4 p.m.

Primary to come:
The week will kick off with a $3.5 billion sale of Series 2023 taxable customer rate relief bonds from the Texas National Gas Securitization Finance Corp. The sale, planned for Thursday by Jefferies LLC, will consist of $1.76 billion of Series A1 term bonds in 2035 and $1.76 billion of Series A2 term bonds in 2041.

That deal will be followed in size by a $1.8 billion sale of taxable various purpose general obligation bonds from California. The Wednesday sale will be senior-managed by Wells Fargo Bank Municipal Finance Group and is rated Aa2 by Moody’s Investors Service, AA-minus by S&P Global Ratings, and AA by Fitch Ratings.

The District of Columbia is planning a $826.3 million sale of GO refunding bonds on Thursday. The sale consists of $587 million in Series 1 and $239 million of Series 2 and will be senior managed by Morgan Stanley & Co. The bonds are rated Aaa by Moody’s and AA-plus by S&P and Fitch.

Louisiana will bring to market $200 million of revenue refunding bonds from the Parish of St. John the Baptist on Thursday in a remarketing led by PNC Capital Markets LLC. The deal, which is rated Baa3 by Moody’s and BBB-minus by S&P and Fitch, is a remarketing of Series 2017 on behalf of the Marathon Oil Corp. project. The financing consists of sub-series 2017 A non-AMT paper which contains a term bond in 2037.

Connecticut Housing Finance Authority will market $168 million of mortgage finance program bonds in a Wednesday sale by BofA Securities. The deal — which is rated triple-A by both Moody’s and S&P — consists of Series A social bonds maturing serially from 2023 to 2035 and term bonds in 2038, 2043, 2048, and 2053.

A $153.7 million sale of auxiliary facilities system refunding revenue bonds will come to market from the Board of Trustees of the University of Illinois on Thursday. The Series 2023 bonds, which are rated Aa3 by Moody’s and AA-minus by S&P, are being senior-managed by JPMorgan Securities.

The Metropolitan Atlanta Rapid Transit Authority is scheduled to bring $150 million of sales tax revenue refunding bonds to market on Wednesday. The Series 2023 green bonds are being senior managed by Goldman, Sachs and are rated Aa2 by Moody’s and AA-plus by Standard & Poor’s and Fitch.

Competitive:
Baltimore County, Maryland, will sell $225 million triple-A-rated GO bonds Wednesday, Nebo, S.D., Local Building Authority will sell $100 million lease revenue bonds.

The Baltimore deal matures serially from 2024 to 2053, while the South Dakota deal matures serially 2024 to 2038 and is rated Aa3 by Moody’s and AA-plus by Fitch.

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