Volatile USTs dragging down munis in December

Municipals ignored losses in U.S. Treasuries Friday ahead of another week without new-issue supply to provide direction. Equities saw losses.

Triple-A muni yield curves were unchanged while USTs saw losses of up to six basis points while the 10-year UST closed the session above 4.6%.

While Friday’s muni session was muted, the damage of a volatile UST market, paired with low new-issue supply and year-end positioning, has weighed on the asset class in December.

As the year-end approaches, municipals will close December deep in the red. The Bloomberg Municipal Index is at -1.80% in December with +0.70% returns year-to-date. High-yield is seeing losses of 2.03% this month but returning 5.92% in 2024.

Taxable munis are losing 2.50% in December with 1.53% gains year-to-date. Short index munis are at +0.15% for December and +3.05% in 2024.

USTs are seeing losses of 1.68% in December with returns at 0.43% in 2024 while corporates are at -1.86% in December and +2.20% in 2024.

“Much of the next few weeks’ trading will focus on supply and demand, with the net figure suggestive of potential upward pressure should the individual component (via separately managed account programs and open-end/exchange-traded funds) become more cautious,” Kim Olsan, senior fixed income portfolio manager at NewSquare Capital.  

There are no new-issues of size on the calendar the week of Dec. 30 and Bond Buyer 30-day visible supply sits at $5.55 billion, but “just about an $8 billion differential exists between expected supply and implied demand from redemptions in the next 30 days — which happens to coincide with the next Federal Open Market Committee meeting,” she said. 

January’s calendar is building across various sectors, Olsan noted. Washington State is on the competitive calendar with a total of $1.05 billion of general obligation bonds the week before the FOMC meeting, several utility credits will price mid-month and local Texas issuance is already approaching $1 billion par, she noted.

January is traditionally a strong month for munis, but elevated supply and Treasury rate volatility could be tailwinds, said Matthew Norton, chief investment officer of municipal bonds at AllianceBernstein.

January may end up being heavier month for issuance as “given the uncertainty around tax reform and the potential bills that could be passed, it’s very possible we see that pull forward in supply,” Norton said.

But “if you see elevated supply at the same time as [Treasury rate volatility], people may be nervous of interest rates moving around and potentially money coming out of mutual funds and money flowing out of the municipal bond market,” he said.

Olsan noted this year’s fund flow momentum “has been mostly positive as yields held to a narrower range” than in the volatile years of 2022 and 2023. A “negative loop of upwardly trending yields creating NAV losses and outflows was largely absent this year,” she said.  

“Early 2025 yield trends will determine whether fund buyers remain committed,” Olsan said, adding that January fund flow data over the last 10 years has been negative only in 2022. 

Yield trends in 2024 also show how lower-rated muni credits have outperformed.

“The credit story has been a powerful one this year, despite favorable high-grade yields for most of the year,” Olsan noted.

Olsan looked at spreads between A-rated and AAA-rated GOs and revenue bonds in various parts of the curve. In the 10-year range, the differential between A-rated GOs and revenues “has been negligible.”

“Implied spreads have averaged 32-35 basis points over the AAA MMD spot, with narrow trading ranges over the year,” she said, adding, as compared to the more volatile 2023 cycle, this year’s median spreads have only contracted about two basis points.

Longer maturities show wider gaps to AAA bonds but have also traded in a tight range, she said.

Single-A GOs due in the 20-year area carry spreads of +40/MMD and single-A revenues “are only a nominal five basis points wider,” Olsan noted. “Given the yield back up in December, absolute levels have reached 4.00% or better.”

Returns in the single-A category this year sit well above the broad index and higher-rated credits, she said.

Bloomberg Barclay’s A-rated index has gained 1.4% or 75 basis points above a main index and 140 basis points over AAA-rated bonds.

Revenue bonds overall have outperformed GOs by 60 basis points in 2024, posting a 0.8% gain. “That gap is narrower than the 2023 revenue index gain which was 120 basis points higher than GOs,” she said.

AAA scales
MMD’s scale was unchanged: The one-year was at 2.86% and 2.82% in two years. The five-year was at 2.87%, the 10-year at 3.08% and the 30-year at 3.92% at 3 p.m.

The ICE AAA yield curve was unchanged: 2.90% in 2025 and 2.84% in 2026. The five-year was at 2.88%, the 10-year was at 3.08% and the 30-year was at 3.87% at 3 p.m.

Bloomberg BVAL was unchanged: 2.97% in 2025 and 2.82% in 2026. The five-year at 2.90%, the 10-year at 3.14% and the 30-year at 3.85% at 3 p.m.

The S&P Global Market Intelligence municipal curve was unchanged: The one-year was at 2.88% in 2025 and 2.81% in 2026. The five-year was at 2.87%, the 10-year was at 3.08% and the 30-year yield was at 3.87% at 3 p.m.

Treasuries saw losses.

The two-year UST was yielding 4.328% (flat), the three-year was at 4.368% (+1), the five-year at 4.461% (+3), the 10-year at 4.625% (+5), the 20-year at 4.905% (+6) and the 30-year at 4.817% (+6) at 4 p.m.