Bonds

A steady tone for munis post-Fed rate hike, USTs rally

Municipals were mostly steady Wednesday while U.S. Treasury yields rallied on the short end following the Federal Open Market Committee decision to raise a quarter point, with language that may hint at a pause. Equities were mixed.

In his press conference, Chair Jerome Powell stressed the panel’s commitment to lowering inflation and spoke of the tight labor market, although he said there were signs labor “was coming back into balance.”

While inflation has moderated, he said, it is still too high.

Powell said “a decision on a pause was not made today,” adding that the panel will be data-dependent and decide the next steps on a meeting-by-meeting basis. Whether rates are sufficiently restrictive now, Powell said, “it’s an ongoing assessment.”

The municipal market was little changed following Wednesday’s decision by the FOMC to raise interest rates by 25 basis points, and some even noted a firmer tone to the market.

“Munis have cheapened up a little bit the last week on percentages, so they are a little more attractive,” he added.

Throughout the past week, “UST securities have been trading beyond a previously tighter range with greater volatility, bouncing among reaction to a flight-to-quality bias, economic data prints, an approaching FOMC meeting, and Treasury market offerings,” said Jeff Lipton, managing director of credit research at Oppenheimer Inc.

Munis, he said, “following a heavy sell-off given the unsustainable richness of the tax-exempt curve, with greater corrections on the short-end, have settled into a very tight trading range with relative stability ahead of the FOMC meeting.”

Ratios have climbed in recent sessions. The two-year muni-Treasury ratio Wednesday was at 68%, the three-year at 69%, the five-year at 69%, the 10-year at 69% and the 30-year at 91%, according to Refinitiv MMD’s 3 p.m. ET read. ICE Data Services had the two-year at 68%, the three-year at 69%, the five-year at 68%, the 10-year at 68% and the 30-year at 91% at 4 p.m.

“The frothy price levels on the short-end of the muni curve actually made similar maturity UST securities more compelling on a tax-adjusted basis,” he said.

Meanwhile, the Investment Company Institute reported investors pulled $323 million from to mutual funds in the week ending April 26, after $377 million of outflows the previous week. Exchange-traded funds saw inflows of $706 million after $716 million of outflows the week prior, per ICI data.

However, the trader said there is a fair amount of available cash awaiting investment in the municipal market and any recent outflows have rebounded to net inflows so far this week, which is a boost.

“Munis actually feel OK,” he said. “Some of the deals coming are getting done and the balances from deals are getting chipped away at a slightly better bid side.”

Overall, Lipton said the market’s expectations were realized by the outcome of the decision, and he said it also signaled that the banking crisis is manageable.

“The initial reaction was what was expected and now we will get a further verification with [Powell’s] comments,” he added.

Technical conditions “should improve with expanding demand amid heavier reinvestment needs, thus setting up the month of May for better performance, with single-digit positive returns a very real possibility,” according to Lipton.

This technical support, he said, “should continue into June and July, with anticipated positive returns in those months as well.”

While issuance may advance, he expects “the market to manage the supply fairly well amid a more stable rate environment.”

Lipton said May could “see some type of return to positive fund flows, but we are not signaling a cyclical shift just yet.”

“Better value opportunities may be found on longer-dated exempts and even on mid-range investment grade cohorts with a focus on certain revenue bond structures,” he said.

He noted there is “much to talk about now with the First Republic/J.P. Morgan Chase deal in place.”

Of First Republic Bank’s “approximately $30 billion in securities to be acquired by J.P. Morgan,” munis make up about $19.4 billion.

“Although significant, this figure is down from a year ago as many banks liquidated muni holdings in 2022,” Lipton said. “Assuming that these securities will be acquired at discounted levels, there is probable motivation for J.P. Morgan to largely hold these muni positions with a degree of attention paid to credit and structure.”

Thus, he does not “expect any material dislocations to the muni market from the First Republic developments,” but noted he “will be monitoring BlackRock’s liquidation of muni bonds previously held by [Silicon Valley Bank].”

The sale of these securities, he said, “will be made in tranches and will take place over time.” Lipton believes “that market pricing has already accounted for what should be an orderly liquidation of muni assets, but [he is] prepared to experience a degree of market dislocation.”

The muni asset class is “well-positioned and should outperform other fixed income investment classes through an anticipated recession with respect to credit, even though muni credit has effectively peaked,” according to Lipton.

“Munis will offer defensive attributes to an investment portfolio, and we suspect that institutional buyers will consider munis more closely,” he said. “For the individual muni investor, the unfolding First Republic events, along with previous banking scenarios, should bring about calm and help to keep financial stability in place and disruptive market forces at bay.”

In the primary market Wednesday, the sole deal of size came with Portland, Oregon, (Aa2/AA//) selling $426.670 million of second lien sewer system revenue and refunding bonds, to Morgan Stanley in the competitive market, with 5s of 12/2023 at 3.00%, 5s of 2028 at 2.42%, 5s of 2033 at 2.48%, 5s of 2038 at 3.13%, 5s of 2043 at 3.45% and 5s of 2047 at 3.71%, callable 6/1/2033.

Secondary trading
Connecticut 5s of 2024 at 3.10% versus 3.19% Tuesday. NYC 5s of 2024 at 3.04%-2.90% versus 3.10% Tuesday. Durham, North Carolina, 5s of 2025 at 2.73%.

DC 5s of 2028 at 2.42%. Boston 5s of 2029 at 2.29%. Maryland 5s of 2030 at 2.36% versus 2.37% on 4/24.

Ohio Water Development Authority 5s of 2032 at 2.40%-2.39% versus 2.42% Monday and 2.47% original on 4/27. Maryland 5s of 2034 at 2.45% versus 2.17% on 4/11. Washington 5s of 2034 at 2.53% versus 2.55%-2.56% Monday and 2.56% original on Friday.

NYC TFA 5s of 2044 at 3.59% versus 3.64% on 4/20. San Jose Financing Authority 5s of 2047 at 3.43% versus 3.50%-3.52% on 4/20 and 3.31% on 4/17.

AAA scales
Refinitiv MMD’s scale was bumped up to two basis points: The one-year was at 3.00% (unch) and 2.69% (unch) in two years. The five-year was at 2.36% (-2), the 10-year at 2.36% (unch) and the 30-year at 3.39% (unch) at 3 p.m.

The ICE AAA yield curve was bumped up to two basis points: 3.03% (flat) in 2024 and 2.72% (flat) in 2025. The five-year was at 2.35% (-1), the 10-year was at 2.32% (-1) and the 30-year was at 3.39% (-2) at 4 p.m.

The IHS Markit municipal curve was bumped up to two basis points: 2.99% (unch) in 2024 and 2.69% (unch) in 2025. The five-year was at 2.36% (-2), the 10-year was at 2.35% (unch) and the 30-year yield was at 3.39% (unch), according to a 4 p.m. read.

Bloomberg BVAL was bumped up to two basis points: 2.81% (unch) in 2024 and 2.68% (unch) in 2025. The five-year at 2.34% (-1), the 10-year at 2.33% (-1) and the 30-year at 3.41% (unch) at 4 p.m.

Treasuries were firmer.

The two-year UST was yielding 3.857% (-12), the three-year was at 3.551% (-14), the five-year at 3.330% (-13), the 10-year at 3.350% (-8), the 20-year at 3.763% (-5) and the 30-year Treasury was yielding 3.682% (-2) at 4 p.m.

FOMC
As expected, the Federal Open Market Committee raised the Fed funds rate target by 25 basis points to a range of 5% to 5.25% and espoused conditions it will watch to determine future monetary policy.

The FOMC “will take into account the cumulative tightening of monetary policy, the lags with which monetary policy affects economic activity and inflation, and economic and financial developments,” to determine “the extent to which additional policy firming may be appropriate the post-meeting statement said.

“Tighter credit conditions for households and businesses are likely to weigh on economic activity, hiring, and inflation,” according to the statement. “The extent of these effects remains uncertain. The Committee remains highly attentive to inflation risks.”

The previous statement mentioned more tightening might be appropriate, but that was absent this time. Combined with the mention of lags, many took that to mean a pause could be ahead, although others disagreed.

While the FOMC discussed a pause, Powell said, it was not considered for this meeting.

“The Fed is no longer flagging that further hikes should clearly be expected but this falls short of a strong commitment to ‘pause’ on rate hikes,” said Fitch Ratings Chief Economist Brian Coulton. “They are still talking about how they will determine the ‘extent’ of additional policy firming — not whether additional tightening is needed or not,” he said, suggesting they “left the window open for future hikes.”

Edward Moya, senior market analyst at OANDA, said, “Credit tightening is about to cripple the economy and it appears that as long as we don’t get a perfect storm of hotter-than-expected labor and inflation data, the Fed will keep rates on hold for at the very least till the end of the year.”

“Recent data reflect a moderating but resilient picture of the U.S. economy, so today’s rate hike was widely anticipated,” said Whitney Watson, global co-head and co-CIO of fixed income and liquidity solutions at Goldman Sachs Asset Management. “Inflation is trending in the right direction, but progress has been bumpy. A pause in rate actions is therefore appropriate, but further tightening is plausible should inflation prove sticky.”

“From a tactical perspective, we think market-implied pricing for policy easing later this year has room to unwind further. Structurally, we think higher yields and a world of greater uncertainty create a strong case for investors to restore allocations to high-quality core bonds,” she said.

While Fed officials’ talks have recently “indicated an increasing amount of disagreement regarding the next steps for policy, this was another unanimous vote,” said Mortgage Bankers Association SVP and Chief Economist Mike Fratantoni. “We expect that the Fed will be ‘data dependent,’ and certainly would react to any renewed increase in inflation, but today’s statement is consistent with a plan to pause rates at this level.”

The statement provided a bit of an oxymoron “as it hints at a hawkish pause,” said Ken Mahoney, CEO of Mahoney Asset Management.

“The Fed will almost certainly pause interest rate increases before inflation returns to 2%, meaning there’s more to today’s decision than meets the eye,” said Morning Consult Chief Economist John Leer. “The data has yet to indicate the Fed has won its battle against inflation, and Chair Powell is not ready to declare victory. An upside inflation surprise next month could prompt additional tightening.”

Wells Fargo Securities Chief Economist Jay Bryson said the FOMC “does not appear to be pre-committing to another rate hike.” While another rate hike can’t be ruled out, he said, “that decision will depend crucially on incoming data over the next six weeks. In our view, the bar to a rate hike on June 14 is higher than it has been at past meetings since March 2022.”

Primary on Tuesday
Mesirow Financial Inc. preliminarily priced for Chicago (/AA/A/AA+/) $579.635 million of second lien water revenue bonds. The second tranche, $255.390 million of new-issue bonds, Series 2023A, 5.25s of 11/2048 at 4.14%, 5.25s of 2053 at 4.24%, 5s of 2058 at 4.34% and 5.5s of 2062 at 4.24%, callable 5/1/2033.

The second tranche, $324.245 million of refunding bonds, Series 2023B, with 5s of 11/2023 at 3.30%, 5s of 2028 at 2.88%, 5s of 2033 at 3.03%, 5s of 2038  at 3.75% and 5s of 2040 at 4.16%, callable 5/1/2032.

The deal was upsized.

Primary to come:
Alabama’s Black Belt Energy Gas District (A2///) is set to price $471.3 million of gas project revenue bonds next week. Goldman Sachs & Co. 

Johnson City, Tennessee, Health & Educational Facilities Board (/A-/A/) is set to price $187.5 million of hospital revenue improvement and refunding bonds on behalf of Ballad Health on Thursday. Serial bonds 2024 to 2034, term in 2033. Banc of America Securities.

Oregon (Aa1/AA+/AA+/) is set to price $159 million of GO paper. Serial bonds 2024 to 2043, terms in 2043, 2048, 2053. UBS Financial Services.

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