Bonds

Munis sell off on long end, mutual fund outflows intensify

Municipals sold off 10 years and out Thursday with triple-A benchmark yields rising up to double-digits on the long end as municipal bond mutual fund outflows increased nearly threefold from the week before to top $3.4 billion. U.S. Treasuries were weaker and equities were mixed.

Triple-A benchmarks rose seven to 12 basis points 10 years and out, depending on the scale, while USTs rose five to nine basis points five years and out.

On Thursday, the two- and three-year muni-UST ratios are around 65% to 68%. The five-year was at 69%, the 10-year at 82% and the 30-year at 101%, according to Refinitiv MMD’s 3 p.m. read. ICE Data Services had the five at 71%, the 10 at 88% and the 30 at 103% at a 4 p.m. read.

Outflows from municipal bond mutual funds intensified as investors pulled $3.416 billion out of funds in the latest week, versus the $1.180 billion of outflows the prior week, according to Refinitiv Lipper data.

High-yield saw outflows of $1.218 billion after $166.572 million of outflows the week prior. Exchange-traded funds saw outflows to the tune of $310.916 million after $472.054 million of outflows the previous week.

The municipal market was closer to holiday mode Thursday as it held its breath ahead of employment data expected Friday. 

“Today’s market is weaker across the board by five to seven basis points.” Michael Pietronico, chief executive officer of Miller Tabak Asset Management, said Thursday.

“There’s not a tremendous amount of selling, but very sporadic buying interest ahead of tomorrow’s employment report,” he said. 

Others said there was some brisk business — but the market already took a break from its normal working pace ahead of the long weekend.

“Ahead of the Labor Day holiday weekend, primary market business was getting done with competitive deals receiving strong bids earlier in the week,” Jeff Lipton, head of municipal credit and market strategy municipal capital markets at Oppenheimer Inc., said Thursday.

Bids were being cut on Thursday from initial competitive scales, while negotiated deals experienced good placement with a number of over-subscriptions, he added. 

“Issuers are likely to remain tentative until after this month’s FOMC meeting, and possibly through the balance of the year,” Lipton suggested. “Those issuers with immediate capital needs and relatively less budgetary flexibility will be the ones front-and-center in the new-issue market,” he added. 

Retail participation has been quiet this week given the end of summer vacations and distractions and heated concerns over inflation and rising rates, according to Lipton. “Nevertheless, more compelling yields and cheaper valuations are likely to draw more active retail interest, yet such interest will be measured against what is otherwise a traditionally weaker climate for munis in September.”

“We’ve been in a period over last three years where there’s been a lot of uncertainty in the market,” said Doug Longo, co-head of product specialists and vice president at Dimensional Fund Advisors. “As we get new information, it creates a lot of volatility as that information gets priced in.”

The markets, though, are behaving the way they should in terms of pricing and new information, he noted.

Munis started to sell off at the beginning of the year. In May, they became relatively cheap compared to USTs, he said. Muni-UST ratios were over 100%, “so they kind of took a step forward in terms of the market, and then they’d become a little bit richer, with many ratios coming back down in June,” he said.

“So we’ve seen a lot of demand, with the yields increasing in May, that maybe created a little bit more pressure,” Longo noted.

As ratios rise, it creates an opportunity for crossover buying.

And while investors’ “natural habitat might be in taxable bonds, when you start to look at ratios increasing, if you get fairly tax-exempt income, it might pull some people into the market that normally wouldn’t be there,” he said.

Yields have been rising since the start of the year. The one- and two-year triple-A muni is up 211 and 204 basis points, respectively, while the 10-year triple-A muni has risen 191 basis points, per MMD.

This, he said, causes the muni curve to flatten.

“We don’t want to get into causation in terms of what’s causing the curve to flatten, but we do see the market is pricing in lower [than] expected inflation,” he said. “So that could be a part of it.

August recap
In August, ”high grade munis outperformed the U.S. Treasury Index, which returned -2.5% during the month,” according to Barclays PLC. MMD-UST ratios were “mixed across the curve, with the intermediate end outperforming,” said Barclays strategists Mikhail Foux, Clare Pickering and Mayur Patel.

“Spreads for the taxable municipal aggregate-eligible index were 11 bp tighter, while those for the credit long index were flat in August,” they noted.

Muni issuance totaled $36 billion, up 35% from July, with net issuance of negative $2 billion, they said. For September, they expect $33 billion to $38 billion supply, with net issuance of $15 billion.

August redemptions were $38 billion, “slightly lower than the average for the month in recent years, and investors also received about $12 [billion] in coupon payments,” they said. They expect redemptions to decrease significantly as the summer seasonals end, and they forecast $17 billion to $20 billion in bond redemptions and about $10 billion in coupon payments. 

Muni fund flows were slightly negative in August, with outflows averaging about $150 million per week, per Refinitv Lipper. As of Aug. 24, fund outflows had totaled about $500 million during the month and $81 billion year-to-date, they noted.

Informa: Money market muni assets rise
Tax-exempt municipal money market funds saw inflows continue as $1.39 billion was added the week ending Monday, bringing the total assets to $101.25 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 1.23%.

Taxable money-fund assets added $6.23 billion to end the reporting week at $4.418 trillion of total net assets. The average seven-day simple yield for all taxable reporting funds rose to 1.89%.

Employment report preview
With members of the Federal Open Market Committee on the fence trying to decide between a 50- and 75-basis-point rate hike later this month, Friday’s employment report could push the decision, analysts said.

The report “will be a critical, if not deciding, factor on which side of that coin the FOMC ultimately lands,” said Scott Anderson, chief economist at Bank of the West.

Recent data suggest the labor market is “hot or even overheating,” he said, so the markets are thinking the hike will be 75 basis points. Anderson expected a gain of 325,000 jobs for August. If more jobs were created, he said, “expect those market probabilities of a 75-basis-point rate hike to swiftly move toward certainty.”

Still, he noted, Wednesday’s ADP report “showed a noticeable cooling in private service employment growth in August.” A miss to the downside could tilt the decision toward a half-point.

Mark Hamrick, senior economic analyst at Bankrate, discounted the importance of a downside miss. “The Fed would view a weaker-than-expected payrolls reading as just one data point amid many other reports pointing to a still strong or robust job market,” he said, noting that Federal Reserve Board Chair Jerome Powell has said often that one report isn’t a trend.

The Fed sees the tight labor market “as a source of demand that’s out of alignment with supply,” Hamrick said. “The Fed can only address demand through higher interest rates and will continue to push that trigger. Officials are eager to see the forthcoming iterations of inflation data as they look toward their September meeting.”

If the numbers come in as expected, about a 300,000 gain, he said, it would be the lowest number of jobs added in a month in more than a year.

“As of last check with 11.2 million job openings (from the JOLTS report) and 5.7 million unemployed persons in the U.S., labor supply and demand remain substantially mismatched. The Federal Reserve views this mismatch as another call to action, or higher interest rates,” Hamrick said.

“A weak jobs number may imply a less aggressive Fed, which could result in strong performance for risky assets,” said Brendan Murphy, head of global fixed income, North America, at Insight Investment. “The best outcome for risk assets is a jobs number consistent with a soft-landing scenario for the Fed.” That would be around 150,000 jobs added, he said.

Insight expects a 75 bp hike at the upcoming meeting, Murphy said, “so even a very strong number is unlikely to result in more than that.”

But if the number is weaker than expected, it “will likely mean that we get a 50 bp increase in September which should provide some relief for markets given that 75 bps is mostly priced.”

July’s 528,000 gain could be revised down, said David Page, head of macroeconomic research at AXA Investment Managers, with a 250,000 increase for August, although he’ll be closely watching “the divergence between establishment and household surveys, believing that contains a lot of information.”

Earnings also will ease, he said.

“We would see these developments as consistent with Fed hiking by 50 bps in September,” Page said. “We expect further signs of labor market slowdown to underpin further deceleration in pace of tightening to year end. However, we will be watching to upside surprises in August as a potential trigger for continued 75 bp hikes.”

Despite recession talk, “nonfarm payrolls point to a labor market that is still on fire,” noted Wells Fargo Securities Senior Economist Sarah House, Econometrician Azhar Iqbal and Economic Analyst Karl Vesely. “Payroll growth has surprised to the upside for four straight months, and not just by a little.”

The upside surprise is a result of other data showing the labor market is cooling, they said, pointing to the ISM surveys’ employment component, which have been contractionary the past four months; jobless claims; hiring intentions; and job openings.

“We believe the labor market is not in the immediate trouble reflected by the past few months’ ISM readings and rise in initial claims since the spring, but it is not as impervious to the deteriorating growth conditions as nonfarm payroll growth implies,” they said. They see payroll growth slowing the rest of the year.

The Fed wants to see some softening of labor market conditions, noted Wilmington Trust Chief Economist Luke Tilley, “but are still waiting” for that to happen. Wage pressures accelerated the past few months, he said, and the labor force participation rate will need to rise to change that. “Workers have bargaining power.”

The economy is slowing, as will inflation, Tilley said, but the “labor market is the risk.”

If inflation plays out according to plan, Wilmington Trust expects a terminal rate of 3.25% or 3.50%. “If the labor market remains tight and wage pressures remains high, we expect the Fed to hike more,” Tilley said.

Secondary trading
North Carolina 5s of 2023 at 2.30% versus 2.24% Friday. DASNY 5s of 2024 at 2.41%. NYC TFA 5s of 2024 at 2.44%. Maryland 5s of 2025 at 2.35% versus 2.34% Wednesday.

NYC TFA 5s of 2029 at 2.77%. California 5s of 2030 at 2.66%-2.68% versus 2.15% on 8/12. NYC Municipal Water Finance Authority 5s of 2032 at 2.87%.

Maryland 5s of 2036 at 3.14% versus 2.89% on 8/22 and 2.81% on 8/18. Prince George’s County, Maryland, 5s of 2037 at 3.18% versus 3.01% on 8/24 and 2.74% on 8/16. Montgomery County, Maryland, 5s of 2037 at 3.18% versus 2.86% original on 8/18.

California 5s of 2042 at 3.65% versus 3.48%-3.45% Monday and 3.70% on 8/25. DASNY 5s of 2046 at 4.05%-4.04%.

AAA scales
Refinitiv MMD’s scale was cut up three to 12 basis points at the 3 p.m. read: the one-year at 2.28% (+7, no Sept. roll) and 2.31% (+3, no Sept. roll) in two years. The five-year at 2.35% (+3, no Sept. roll), the 10-year at 2.67% (+8, no Sept. roll) and the 30-year at 3.41% (+12).

The ICE AAA yield curve was cut four to 10 basis points: 2.32% (+4) in 2023 and 2.36% (+4) in 2024. The five-year at 2.40% (+4), the 10-year was at 2.76% (+7) and the 30-year yield was at 3.40% (+10) at a 4 p.m. read.

The IHS Markit municipal curve was cut two to 10 basis points: 2.24% (+3) in 2023 and 2.32% (+3) in 2024. The five-year was at 2.36% (+5), the 10-year was at 2.68% (+8) and the 30-year yield was at 3.38% (+10) at a 3 p.m. read.

Bloomberg BVAL was cut up to four to eight basis points: 2.32% (+6) in 2023 and 2.32% (+4) in 2024. The five-year at 2.34% (+5), the 10-year at 2.66% (+7) and the 30-year at 3.37% (+8) at 4 p.m.

Treasuries were weaker.

The two-year UST was yielding 3.516% (+2), the three-year was at 3.548% (+3), the five-year at 3.404% (+5), the seven-year 3.370% (+6), the 10-year yielding 3.266% (+7), the 20-year at 3.650% (+8) and the 30-year Treasury was yielding 3.380% (+9) at 4 p.m.

Mutual fund details
Refinitiv Lipper reported $3.416 billion of outflows for the week ending Wednesday following $1.180 billion of outflows the previous week.

Exchange-traded muni funds reported outflows of $310.916 million after outflows of $472.054 million in the previous week. Ex-ETFs, muni funds saw outflows of $3.105 billion after outflows of $707.565 million in the prior week.

The four-week moving average was at negative $1.365 billion from negative $237.526 million in the previous week.

Long-term muni bond funds had outflows of $2.801 billion in the latest week after outflows of $1.030 billion in the previous week. Intermediate-term funds had outflows of $337.136 million after inflows of $38.780 million in the prior week.

National funds had outflows of $2.957 billion after outflows of $1.019 billion the previous week while high-yield muni funds reported outflows of $1.218 billion after outflows of $166.572 million the week prior.

Christine Albano contributed to this story.

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