Munis rallied Tuesday, as yields followed U.S. Treasury yields lower on hopes that an end to the war with Iran is near, even amid overnight strikes.
Muni yields were bumped four to nine basis points, depending on the scale, while UST yields fell five to eight basis points.
The excitement over a potential peace deal between the U.S. and Iran could be felt across financial markets, which largely ignored the U.S. launching "self-defense" strikes overnight and threats of retaliation from Iran over an alleged violation of the ceasefire.
"A lot of the muni market might be just hopeful of any positive news, and so they'll grasp onto whatever we can find, if that's hope of an Iran deal, then maybe that's what we're clinging to, but we certainly need to be a little bit careful until there's actually a deal," said Jim Quealy, director of municipal trading at Appleton Partners.
USTs opened stronger on Tuesday morning in hopes of a resolution, said Kim Olsan, senior fixed income portfolio manager at NewSquare Capital.
Those hopes may fall through, she said, as they have before, "but I do feel, overall, that the Treasury market has sort of found a floor of support.
"The marketplace is giving us an indication that this rise in interest rates has largely been influenced by what's going on in the Middle East in a significant way," said Andrew Clinton, CEO and founder of Clinton Investment Management.
"So the possibility of a cessation of the conflict or reopening of the Strait of Hormuz is flowing through to an expectation that if that was the case, energy prices would fall, that would diminish inflationary impact, and obviously result in lower yields," he said, noting that lingering questions explain why markets are not seeing a larger rally.
Each day without significant escalation in the war "may be perceived as incremental progress, at least for now," said Mohammed Murad, head of municipal credit research at PT Asset Management. "As details of a potential peace agreement emerge, I believe markets' attention may shift to the substance of such deal, and what that could mean for inflation, vessel navigation, and broader regional stability."
Munis played a bit of catch-up Tuesday, Quealy said.
"We pretty much always are taking our cue from the Treasuries, and Treasuries rallied a decent amount from Tuesday through the end of last week in that like 15-basis-point range. Munis didn't really follow through as much … so today's a little bit of a catch-up on that," he said.
Even with the catch-up, a potential resolution to the war was a major push for strength in the muni market, said Jeff Timlin, managing partner and head of municipal bond investing at Sage Advisory.
Last week's "extreme bearishness tone" probably pushed yields and levels of different asset classes a little bit too far, he said.
"Heading into a long weekend with the illiquidity around Friday, and then another extra day off probably gave people some pause in terms of allocating to fixed income, but now that that's behind us, and we've got several weeks before another long weekend, again with the positive tone we're seeing in a direction to get a deal done," he noted.
The market seems a little bit "frothier," and people are dipping their toes back into the water, Timlin said.
Tuesday was a "bond grab," said Ajay Thomas, head of public finance at FHN Financial.
The upcoming June 1 redemptions, Iran hopes driving down oil prices, plus positive inflows last week, combined to make munis more attractive.
Thomas said it's still unclear whether the market's positive tone will continue throughout the week. If peace talks turn sour, there could be a "snap back," he said, but if the countries reach a deal that seems to have legs, the rally may continue.
The spread relationship between returns on equities and the bond market has been narrowing lately, Thomas said.
"There could be a decision from investors that feel that the equities market has run up here pretty good, and it may be a little bit overbought," Thomas said. Those investors may want to "transition into something with more stability in the bond market, because they're able to get a return that's somewhat commensurate now, or getting closer to what they could earn in the stock market."
However, Quealy argued, even with the rally Tuesday, "I don't think that we're overbought in munis.
"We've caught up to where we probably should be with the rally [Tuesday]. So, I don't think it's a situation where munis have gotten a little over their skis. I think we're probably in a pretty good spot now," he said.
If the muni market rallies another 10 basis points on Wednesday with no additional news, then munis would probably be a little bit overbought, but "we don't seem to be there," Quealy said.
Market participants, though, should be "careful" about chasing the rally because it could be announced Tuesday night that peace talks are off and "we're back to ground zero," which could prompt another sell-off, Quealy noted.
New-issue market
In the primary market Tuesday, Goldman Sachs priced for the Southern California Public Power Authority (Aa3///) $808.72 million of clean energy II project revenue bonds, Series 2026A, with 5s of 11/2029 at 3.65%, 5s of 2031 at 3.90% and 5s of 2033 at 4.10%, callable 8/2033.
