Municipals were little changed Monday on light trading while U.S. Treasury yields fell and equities pared back gains.
As the second half of the year approaches, municipal market fundamentals are strong and participants say save for any volatility in other parts of the economy — namely inflation or the unlikely event the Federal Reserve raises interest rates — the tailwinds are wholly in the market's favor.
The expectation the U.S. economy will be fully reopened in short order, combined with strong monetary and fiscal stimulus, growth has been better-than-expected from earlier in the year and will likely continue.
"This will contain longer-term rates and support liquidity conditions across fixed income markets," Nuveen said in a mid-year report. "All of these factors create tailwinds for municipal bonds."
"Municipal valuations are looking rich (more so for high grade than high yield) and we think fundamentals warrant current pricing," said John Miller, head of municipals at Nuveen.
Inflation is always a risk to municipal bond investors, Miller said, but Nuveen expects inflation pressures to "remain modest enough to allow the Fed to maintain its interest rate positioning. We are watching for signals that the Fed might begin winding down its quantitative easing programs (i.e., another 'taper tantrum') that may spark volatility."
Nuveen is closely watching interest rate volatility. "Municipal yields have advanced over the course of 2021, but have lagged Treasuries," Miller said. "We expect further upward pressure on yields across fixed income markets, which could create obstacles."
Even so, credit conditions have been favorable, and defaults have been rare and isolated, "thanks in part to massive spending by state and local governments," Miller wrote. "Technical factors have also benefited municipal bonds as supply has not kept pace with extremely high demand."
And while muni yields have risen — the 10-year AAA spot is currently about 40 basis points above its opening yield in January — the curve has undergone a shift during the second quarter, said Kim Olsan, senior vice president at FHN Financial.
"Based on a reach for yield, the 10- to 30-year slope has flattened nearly 20 basis points — during the quarter, the average 10-year rate has been 0.94% as compared to the last five-year weekly average of 1.74%," she said. "The outperformance of tax-exempts to taxable bonds has resulted in relative value ratios holding in the 60% range for much of the time."
On Monday, municipal-to-UST ratios were about the same as Friday, at 69% in 10 years while the 30-year was at 73%, according to Refinitiv MMD. ICE Data Services had the 10-year muni-to-Treasury ratio at 67% and the 30-year at 72%.
Refinitiv MMD had the five-year at 56% and ICE pegged it at 54%.
Olsan noted several other changes so far in 2021 from past years, particularly dealer carry. It has been held to half that of the last several years, running at a weekly average of $9 billion, she said.
The pre-pandemic the figure was $16 billion and across a wider timeframe the level reached $18 billion, according to Olsan.
"Some of the reduction is driven by risk-off modeling but another component that can’t be overlooked is the declining share of tax-exempt float vis-à-vis the overall total," she said. "In 2016, taxable volume was a mere 7% of all issuance, but by 2018 had grown to 10% and in 2020 it reached a 44% market share."
Adding to the changes is that par value posted for sale has fallen to $389 million per day, down from $535 million in the preceding five years.
"The drop can be attributed back to heavy allocations in the asset class, negating the need for cash raises," she said, adding, low rollover yields and very limited reinvestment options are preventing sellers from monetizing book gains.
As many participants have noted, fund flows are on fire, holding more than a quarter of the market. Weekly fund flows accelerated during the first quarter and have maintained a "healthy $1.75 billion weekly average during Q2," Olsan said.
"That figure contrasts with the last five-year average of $780 million. The mutual fund segment is approaching the $1 trillion mark of all municipal assets held, with [exchange-traded fund] flows in particular representing a larger share," she said.
Ongoing demand there has provided a key supportive tone to yields.
Scarcity of bonds, as many participants have pointed out, is keeping yields low. But the makeup of the market has also changed and is a contributing factor.
Issuance projections have held steady this quarter as compared to a wider time horizon, running at $11 billion, Olsan said.
"However, built into those figures is taxable-based volume, including corporate-issued CUSIPS," she said. "Through May, 35% of all supply has come in taxable structures. The byproduct of that large a share is a tax-exempt curve that defies broader taxable moves to higher yields."
"As the second half of the year begins, fundamentals will hold their advantage for issuers and continue to force inquiry into value options," Olsan added.
Outside of fundamental and technical factors, Nuveen's Miller noted, the U.S. political environment offers other potential tailwinds for the municipal market.
"Higher tax rates are likely coming, which could further increase demand for tax-exempt municipals," he said. "Should an infrastructure program win passage, it would likely include a municipal bond subsidy program with similarities to the Obama-era Build America Bond program. This could provide additional tailwinds for municipals."
Secondary trading and scales
Trading was sparse.
Anne Arundel, Maryland, 5s of 2022 traded at 0.13%-0.11%. Montgomery County, Maryland, 5s of 2023 at 0.21%-0.20%. New York Environmental Facilities Corp. 5s of 2024 at 0.26%. Anne Arundel 5s of 2024 at 0.26%.
California 5s of 2026 at 0.54%.
Georgia 5s of 2033 traded at 1.12%. Washington 5s of 2035 at 1.25%. Fort Worth, Texas, 4s of 2036 at 1.47%-1.32% versus 1.49% original.
High-grade municipals were little changed on all triple-A benchmarks on Monday. According to Refinitiv MMD's AAA, short yields were steady at 0.12% and at 0.16% in 2021 and 2022. The yield on the 10-year stayed at 1.01% while the yield on the 30-year sat at 1.52%.
The ICE AAA municipal yield curve showed bonds steady in 2022 at 0.11% and 0.16% in 2023. The 10-year maturity was at 1.00% and the 30-year yield sat at 1.51%.
The IHS Markit municipal analytics AAA curve showed short yields steady at 0.13% and 0.16% in 2021 and 2022, respectively, with the 10-year unchanged at 1.01%, and the 30-year yield sat at 1.52%.
Bloomberg BVAL AAA curve showed short yields steady at 0.12% and 0.15% in 2021 and 2022, with the 10-year flat at 1.00% and the 30-year yield steady at 1.54%.
In midday trading, the 10-year Treasury was yielding 1.47% and the 30-year Treasury was yielding 2.10%. Equities were off, with the Dow Jones down 176 points, or -0.51%, the S&P 500 flat while the Nasdaq lost 0.17%.
Analyzing the Fed
With various Federal Reserve officials airing their views since the Federal Open Market Committee’s latest meeting, it may take a while for members to reach agreement on tapering, according to an analyst.
“The Fed is gearing up to have a robust discussion at the July FOMC meeting and openly airing the debate gives us a sense of important decisions that have to be hammered out, such as the timing and pace of reduction in purchases, said Morgan Stanley Chief U.S. Economist Ellen Zentner in a note. “This is why consensus building takes time.”
Morgan Stanley expects guidance on tapering at the September FOMC meeting, with the first cuts announced in March.
“Though I see the data unfolding in a way that leads the Fed to be in no rush to taper (e.g. we have moved away from the 2Q peak growth in GDP and the M/M change in core inflation will be slowing sequentially),” Zentner said, “I have underscored the risk to our call is an earlier than later start.”
And the Fed presidents who are advocating rate hikes next year, are merely stating the opinions they proffered in the Summary of Economic Projections. Morgan Stanley’s assessment has seven Fed presidents expecting liftoff next year, but five members of the Board of Governors expecting a 2023 initial hike, with only Gov. Lael Brainard expecting the first hike after 2023.
“Investor fears that the Fed may shift in a significantly hawkish direction at some point over the next year have been far too focused on inflation, and far too little focused on employment,” Jonathan LaBerge, vice president at BCA Research. “It is not a coincidence that the Fed’s guidance was updated following the May jobs report, which saw a stronger pace of jobs growth relative to April.”
At that pace, BCA expects maximum employment will be reached between June and September 2022. “We believe that it is likely that the Fed will have raised rates by Q3 of next year, and that a rate hike in the first half of 2022 is a possibility.”
Given the Fed’s belief that inflationary pressures would pass, John Luke Tyner, fixed income analyst at Aptus Capital Advisors, said, “we were surprised to see such a drastic move forward in the Fed governors' dot plot expectations.”
Aptus believes liftoff will occur late next year, “as the market won’t let the Fed run inflation above 2% with real yields being so negative.” And, Tyner, added. “Jerome Powell may not be the Fed chair ultimately making this decision.”
The Fed’s asset purchases have pressured the bond market and with the Fed “owning something to the tune of 30% of all agency mortgage-backed securities … creates supply/demand imbalances. All of that combined with an insane amount of liquidity in the market makes for a difficult environment, as it has pressured rates down,” he said. “This sets the stage, if tapering happens, for another ramp in Treasury yields as seen in Q1 … at least in the near term.”
The mortgage market “quietly” began to price in tapering while “Treasury spreads have widened over the past couple weeks.”
With the real estate market strength, Tyner said, “there is little reason for the continued mortgage purchases. We think it’s likely that those mortgage purchases shift to Treasuries in Q3 of this year followed by Treasury purchases beginning to phase out in the beginning of 2022.”
Separately, manufacturing growth accelerated in Texas in June, as did price and wage pressures, according to the Federal Reserve Bank of Dallas’ Texas Manufacturing Outlook Survey. The production index jumped to 29.4 in June from 15.7 in May and new orders rose to 26.7 from 20.8.
The employment index inched up to 22.9 from 22.7, wages and benefits grew to 48.1 from 38.4, while prices paid for raw materials climbed to 80.8 from 79.9 and prices received for finished goods gained to 42.8 from 38.4. The prices and wages were all at record highs, the Fed said.
Primary market to come
The New York City Municipal Water Finance Authority (Aa1/AA+/AA+/) is set to price $450 million of water and sewer system second general resolution revenue bonds for retail on Tuesday and for institutions Wednesday consisting of fiscal 2022 Series AA-1, $400 million serials 2048 and terms 2051, and $50 million of Series AA-2, serials 2028. UBS Financial Services Inc. will run the books.
The Harris County Cultural Education Facilities Finance Corp. (Aa2/AA/AA/) is set to price on Wednesday $320 million of Texas Children’s Hospital revenue bonds, $245 million Series 2021A and $75 million Series 2021B. Goldman Sachs & Co. LLC is lead underwriter.
The City of Philadelphia (A2//A/) is set to price $298.28 million of AMT PAB airport revenue and refunding bonds on Tuesday. BofA Securities is head underwriter.
The State of New York Mortgage Agency (Aa1///) is set to price for retail on Tuesday and institutions on Wednesday $262.7 million of homeowner mortgage revenue social bonds, $149.7 million of Series 233, serials 2028-2033, terms 2036, 2045, $67 million of Series 235, serials 2022-2028, $45.8 million of Series 237, serials 2025-2030. Barclays Capital Inc. will run the books.
The San Diego Unified School District is set to price on Wednesday $240 million of tax and revenue anticipation notes. BofA Securities is head underwriter.
The Texas Municipal Power Agency (A1///) is set to price on Tuesday $201.6 million of transmission system revenue refunding bonds. BofA Securities is lead underwriter.
The State Building Authority, Michigan, (Aa2//AA-/) is set to price on Tuesday $199.76 million of 2021 revenue bonds Series I (Facilities Program), serials 2021-2026, terms 2038, 2039, 2040, 2041, 2046, 2051, 2056. Siebert Williams Shank & Co., LLC is bookrunner.
Chester County Industrial Development Authority (Aa2///) is set to price on Wednesday $146.9 million of Longwood Gardens, Inc. Project sustainability revenue Bonds, Series 2021. Morgan Stanley & Co. LLC is head underwriter.
The Nebraska Investment Finance Authority (/AA+//) is set to price on Thursday $129.1 million of single-family housing refunding revenue bonds 2021 Series C (Non-AMT) social bonds. J.P. Morgan Securities LLC is lead underwriter.
Collin County, Texas, (Aaa/AAA//) is set to price on Tuesday $103 million of limited tax permanent improvement and refunding bonds, Series 2021, serials 2022-2041. Citigroup Global Markets Inc. will run the books.
The Godley Independent School District (Aaa///) (PSF guarantee) is set to price $94.6 million of unlimited tax school building bonds on Tuesday. Serials 2027-2051. RBC Capital Markets is head underwriter.
In the competitive market Monday, Wayzata, Minnesota, is set to sell $135.75 million of taxable general obligation school building and alternative facilities refunding bonds, Series 2021A (Minnesota School District Credit Enhancement Program) at 11 a.m. eastern.
On Tuesday, Santa Clara, California, (/AA+/AA/) is set to sell $337.7 million of lease revenue bonds at 11:45 a.m.
Hillsborough County, Florida, (Aaa/AA+/AAA/) is set to sell $152 million of utility revenue bonds at 10:30 a.m. and $17.7 million of utility revenue refunding bonds at 11 a.m.
Clark County SD, Nevada, (A1/A+//) is set to sell $200 million of general obligation bonds at 11:30 a.m.
Seattle (Aa2/AA//) is set to sell $261.6 million of municipal light and power improvement and refunding revenue bonds at 10:45 a.m.
On Wednesday, Portland Public School District #1J (Aa2/AA//) is set to sell $401.9 million of taxable full faith and credit bonds at 11 a.m.
