Munis End Stronger as Market Eyes Yield Volatility

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Top-rated municipal bonds finished stronger Thursday, traders said, after new issuance evaporated and yields see-sawed ahead of a holiday-shortened week.

 

Secondary Market

The 10-year benchmark muni general obligation yield fell two basis points to 2.41%, from 2.43% on Wednesday, while the yield on the 30-year GO fell three basis points to 3.14% from 3.17%, according to the final read of Municipal Market Data's triple-A scale.

"Munis have shown a lot of trading today, but the direction of the trade was rather mixed," MMD Senior Market Analyst Randy Smolik wrote in a market comment. "It would appear that some dealers were taking advantage of the semblance of a bid and moving a lot of inventory."

Municipal bond yields have generally been on a slow but steady rise over the past week. Since Feb. 6, yields on the 10-year muni have risen 13 basis points.

Treasuries were stronger on Thursday. The yield on the two-year Treasury dipped to 1.20% from 1.25% on Wednesday, while the 10-year Treasury dropped to 2.44% from 2.50%, and the yield on the 30-year Treasury bond decreased to 3.04% from 3.09%.

 

N.Y. Fed President: 2017 Looking a Lot Like 2016

The Federal Reserve thinks this year will turn out a lot like last year, William Dudley, President of the Federal Reserve Bank of New York and Vice Chairman of the Federal Open Market Committee, said Wednesday night at the Cornell College of Business' annual predictions event in New York City.

Maureen O'Hara, Robert W. Purcell Professor of Management and Professor of Finance at Cornell, moderated the "fireside chat" with Dudley.

Looking ahead, Dudley said the Fed's outlook for 2017 resembles its outlook for 2016.

"We see more of the same – we think the economy is going to continue to grow a little bit above trend and that's going to generate job gains that put more pressure on the labor market," Dudley said, "and as a consequence of that, we think that inflation's going to move back toward our 2% objective."

However, he said there was a lot of uncertainty in the outlook because it was unclear what was going to happen in the areas of healthcare, immigration, trade, tax and fiscal policies.

"We could be completely wrong, but the data that's come out over the last four months has been consistent with our view," he said.

"The baseline forecast is pretty similar for 2017 as in 2016," he said. "And if that happens and we stay on that trajectory, I think as Chair Janet Yellen said [on Tuesday and Wednesday] we would expect to gradually move further monetary policy … to snug up interest rates a little further in the months ahead."

When asked by O'Hara about the current debate about the Dodd-Frank Act in Congress, Dudley said some of the regulations should be revisited.

"I think it makes sense to look at the Dodd Frank Act to see if parts are working and some other parts are not working so well," he said.

"I think there are two things we are trying to accomplish here. Number one is we are trying to make the probability of large, complex financial institutions failing a lot lower than it was before – so that means more capital, more liquidity, better governance, better risk management – we want to keep all these things," he said.

"And the second thing we're trying to do is that if a firm does get into trouble we can actually allow it to fail without it threatening to take down the rest of the financial system," Dudley said. "So keeping all these parts makes a lot of financial sense."

On other sections, he felt it could be modified to provide a little more freedom to equities traders when markets are volatile and to take into account undue hardships visited upon small firms.

"There's a need for relief for smaller banking institutions. The financial crisis was not about small banking institutions – it was about large banking institutions and in particular it was about large broker-dealers," Dudley said. "And so I think the Dodd-Frank Act imposed a lot of compliance and regulatory requirements on smaller banking institutions …. And relief for [smaller banks and credit unions] would be really, really valuable because the burden on them falls disproportionately because they don't have as big an asset base to spread those compliance costs across and I think it has more of a real consequence because a lot of these institutions support small business lending."

In response to a question on a mention of balance sheet normalization in the FOMC's September minutes, Dudley said it was pretty clear that balance sheet normalization was in the background to the current monetary policy.

"My own personal view is 'how soon do we want that process to start?' It depends not just about how much margin you have between the current federal funds rate and zero but also how confident you are that you're actually not going to need to reduce the federal funds rate in the near term," he said. "So to the extent that we become more confident and we become more confident about the economic outlook, that the economy will be sustained, I think that for me, and speaking only for myself, that might may make me a little bit more comfortable to proceed with balance sheet normalization a bit little more quickly."

He said it was important to think of balance sheet normalization not as an active tool, but rather as a passive tool.

Additionally, he said, if the Fed does decide sometime in the future to taper or end the reinvestment "that would also be a way of removing accommodation and so that would be a bit of a substitute for raising short-term interest rates. So I would guess, in my own personal view, is that if we move to balance sheet normalization that might actually stretch out the process of raising short-term interest rates a little but because the two are substitutes for one another."

He said a decision on normalization was not imminent.

"People sometimes think that when we start talking about something in the minutes that we're going to do something momentarily," Dudley said. "Usually it takes a while for us to develop the themes and issues and reach a consensus. So I wouldn't take a lot signals just because in was in the minutes the last time that something near is happening."

 

Primary Market

After a busy two days, the new issue sector slowed down to a crawl, with no major issuance set for Thursday or Friday. The market will be closed on Monday in observance of Presidents' Day.

 

Tax-Exempt Money Market Fund Outflows

Tax-exempt money market funds experienced outflows of $539.1 million, bringing total net assets to $131.27 billion in the week ended Feb. 13, according to The Money Fund Report, a service of iMoneyNet.com. This followed an inflow of $1.30 million to $131.81 billion in the previous week.

The average, seven-day simple yield for the 233 weekly reporting tax-exempt funds was unchanged from 0.22% in the previous week.

The total net assets of the 863 weekly reporting taxable money funds increased $970.3 million to $2.513 trillion in the week ended Feb. 14, after an outflow of $6.54 billion to $2.512 trillion the week before.

The average, seven-day simple yield for the taxable money funds was steady from 0.27% in the prior week.

Overall, the combined total net assets of the 1,096 weekly reporting money funds rose $431.2 million to $2.645 trillion in the week ended Feb. 14, after outflows of $5.24 billion to $2.644 trillion in the prior week.

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