Municipal yields rose on Thursday by as much as six basis points as the correction to higher yields continues, but if inflows are any indication, the technicals (low supply, high demand) surrounding munis won't allow rates to rise much higher in the near-term.
Those inflows keep coming as Refinitiv Lipper reported $1.955 billion into municipal bond mutual funds, in the latest reporting week ended Feb. 15, down from $2.6 billion the prior week. High-yield muni funds reported inflows of $577 million in the latest week, after inflows of $832 million the previous week.
The rise in yields this week could portend a different inflow story for next, and competitive deals from high-grade issuers in Maryland and North Carolina could help direct benchmarks.
Triple-A benchmarks cut curves by three to six basis points, with the largest moves outside of 10 years.
A look back to the lows of mid-August when the 10-year hit just above 0.50% and the 30-year was around 1.28%, ratios to UST sat at about 96% and 106% in 10- and 30-years at the same time.
Fast forward to now, even with the few days of weakness, the ratios are still quite compelling and pushing rich valuations across the muni curve. The relationship tracks with the movements in both markets.
Given the muni yield changes and the once-again little-changed U.S. Treasury market for the second day, municipal to UST ratios rose six basis points to 64% in 10 years and three basis points to 71% in 30 years, according to Refinitiv MMD. ICE Data Services showed ratios rose four basis points to 62% in 10 years and three basis points to 72% in 30. BVAL showed 10-year ratios rose three basis points to 59% and were two basis points higher at 72% in 30 years.
The level to which municipal to U.S. Treasury ratios have declined substantially so far in 2021 is compelling. As a result, taxable equivalent yields (TEY) have moved to ranges where the muni side is equal to or lower than the current UST yield.
Huge inflows into muni funds — with just one outflow report since May 2020 — are helping to create the dynamic of rich valuations (paired with limited tax-exempt issuance), said Kim Olsan, senior vice president at FHN Financial. The longer flows stay well elevated, she and others say, the more exaggerated technical levels become.
At the start of the year, Olsan noted, the five-year AAA TEY was nearly matched to the five-year UST.
Olsan gives a look at the five-, 10- and 20-year TEY versus UST at the start of Thursday. Currently, the AAA TEY is 0.36% against a 0.54% five-year UST. Intermediate high-grade munis carried a 1.15% TEY in early January, about 25 basis points over the 10-year UST.
"The muni has since moved to parity against the UST rate," Olsan noted. "Longer-term AAAs netted a TEY nearly 60 basis points above the 20-year UST to open the year, but that premium has shrunken to just 20 basis points."
There are other reasons for investors' (particularly retail) relationship with munis.
"Current fund flows are indicative of individuals’ future expectations for tax hikes and the need for tax-exempt allocations," Olsan said. "There is also the likelihood that the corporate rate moves higher in the next one to two years, adding more value in tax-exempts for bank- and insurance-oriented investors."
In the primary Thursday, Goldman Sachs & Co. priced the only large deal of note, a $411 million tax-exempt sales tax revenue refunding (FasTracks Project) climate bond certified green bonds for the Regional Transportation District of Colorado's (Aa2/AA-/AA/). Bonds in 2028 with a 5% coupon yield 0.69% (~ +18 to generic triple-A benchmarks), 5s of 2030 at 0.94%, 4s of 2038 at 1.52%, 2s of 2041 at 2.20% (~ +96 to triple-As) and 2.25s of 2045 at 2.30% (~ +91).
A view from the buy-side
Buy-side players said there is little difference in the overall climate of the tax-exempt market month over month with strong demand and limited supply underpinning the market.
Strength from the high-yield sector continues to reinforce the market — from new issuance to fund flows and fund performance.
“The lack of meaningful supply, which led to municipal bond outperformance relative to Treasuries during January, continues to support the municipal bond market here in February,” Anthony Valeri, director of investment management at Zions Wealth Management in San Diego, said.
Municipals, he said, are proving more resilient than taxable bonds during this week’s sell off.
“While the 10-year Treasury yield has increased to a post-pandemic high of 1.30%, the average 10-year, triple-A muni GO yield has yet to break to a new high,” Valeri said. “I'm seeing triple-A eight to 10-year muni yields up by three to four basis points versus eight to nine basis points for Treasuries.”
February is shaping up like January — with continued heavy demand chasing a limited amount of volume in the primary market and historic inflows into bond funds, market experts noted.
Municipal bond funds saw a record $15.9 billion of inflows amid $95 billion of inflows to long-term mutual funds and exchange-traded funds for January, according to Morningstar. The independent research firm noted the healthy inflows partly stem from the anticipation of potential increased federal support for cash-strapped municipalities.
Valeri of Zions agreed, noting, expectations for the next fiscal stimulus package have increased to between $1.3 trillion and $1.5 trillion, along with the prospects of additional taxes in 2022 and beyond.
“The prospect of higher individual tax rates are returning as a positive catalyst in 2021,” he said.
The political landscape is having an impact on the municipal market in more ways than one, according to Van Eck Securities.
“Demand is being driven by anticipation of both higher taxes and more federal support to state and local governments,” the firm said in a Feb. 17 municipal report.
Additionally, the municipal bond market continues to benefit from both strong demand and limited supply, the firm said.
High-yield issuances, in particular, have been a major beneficiary of expected future fiscal support, and a key contributor to the performance of Van Eck’s own Vectors Muni Allocation ETF, the report said.
The exchange-traded fund had a net asset value total return of 1.33% versus 0.64% for the Bloomberg Barclays Municipal Bond Index, according to the firm.
The Van Eck ETF’s asset allocation mix in January was overweight both high-yield and long-duration bonds, it noted.
The largest contributors to the fund’s performance were high-yield, with a return of 2.06%, and long investment grade, with a return of 0.90%, Van Eck said.
“There is a continued strength in the municipal bond market with a bias towards high-yield and long duration investment grade,” the firm wrote.
Initial jobless claims rise, data mostly negative
Data released Thursday was mostly negative, with jobless claims rising, housing starts down and the manufacturing sector off from last month.
Initial jobless claims rose unexpectedly in the week ended Feb. 13 and the number for the week before was revised upward.
Initial claims grew to 861,000 in the week ended Feb. 13 from 848,000 a week before (first reported as 793,000). Continued claims slipped to 4.494 million in the week ended Feb. 6 from 4.558 million a week earlier.
Economists polled by IFR Markets expected 775,000 claims in the week.
Housing starts dropped 6.0% in January to a 1.580 million pace from1.680 million in December, while building permits increased 10.4% in the month to 1.881 million from 1.704 million.
Economists projected 1.655 million starts and 1.680 million permits.
"The weakness in housing starts in January is consistent with our recent builder surveys," said National Association of Home Builders Chief Economist Robert Dietz. "Builders report concerns over increasing lumber and other construction costs and delays in obtaining building materials. Rising interest rates will also erode housing affordability in 2021, as existing home inventories remain low.”
The number of single-family homes where permits were issued where construction hasn’t started rose 9.6% month-over-month and 28.1% year-over-year, he said, as a result of “building material cost increases and delays."
Import prices jumped 1.4% in January after a 1.0% gain in December, while export prices soared 2.5% after a 1.3% increase a month earlier.
Economists expected import prices to rise 1.0% and exports to grow 0.8%.
The Federal Reserve Bank of Philadelphia’s manufacturing survey’s general business conditions index fell to 23.1 in February from 26.5 in January.
Economists saw the index falling to 20.0.
The new orders index slid to 23.4 from 30.0, shipments dipped to 21.5 from 22.7, unfilled orders fell to 12.6 from 25.6, the delivery times index declined to 15.1 from 30.0, inventories rose to 20.0 form 12.6, prices paid grew to 54.4 from 45.4, while prices received slumped to 16.7 from 36.6.
The number of employees index rose to 25.3 from 22.5, while the average workweek gained to 30.6 from 18.6.
The six months from now general business conditions index fell to 39.5 from 52.8.
Also released Thursday, The Conference Board said CEO confidence rose to a 17-year high in the first quarter of 2021, as measured by its index which rose to 73 in the quarter from 64 in the fourth quarter of 2020.
The reading was the highest since a 74 in the first quarter of 2004.
“With the vaccine rollout underway in major economies, CEOs entered 2021 historically upbeat,” according to Dana Peterson, the think tank’s chief economist. “They foresee the economy improving further over the next six months. However, setbacks from the pandemic remain a risk to future growth.”
Refinitiv Lipper reports $1.96B inflow
In the week ended Feb. 17, weekly reporting tax-exempt mutual funds saw $1.955 billion of inflows. It followed an inflow of $2.644 billion in the previous week.
Exchange-traded muni funds reported inflows of $353.171 million, after inflows of $372.334 million in the previous week. Ex-ETFs, muni funds saw inflows of $1.602 billion after inflows of $2.271 billion in the prior week.
The four-week moving average remained positive at $2.242 billion, after being in the green at $2.349 billion in the previous week.
Long-term muni bond funds had inflows of $1.374 billion in the latest week after inflows of $1.652 billion in the previous week. Intermediate-term funds had inflows of $332.887 million after inflows of $572.938 million in the prior week.
National funds had inflows of $1.800 billion after inflows of $2.502 billion while high-yield muni funds reported inflows of $577.723 million in the latest week, after inflows of $832.187 million the previous week.
Secondary market
Trading showed New York City general obligation bonds, 5s of 2023 at 0.23%, Maryland DOT 5s of 2024 at 0.22%, New York Urban Development Corp. PITs, 5s of 2024 at 0.26%, Maryland GOs, 5s of 2025 at 0.29% versus 0.23% Wednesday, Georgia GOs, 5s of 2025 at 0.32%, Irving, Texas GOs, 5s of 2026 at 0.46%, Maryland GOs, 5s of 2028 at 0.61% versus 0.49% on Feb. 8.
California GOs, 5s of 2028 at 0.68%-0.63%. Maryland GOs, 5s of 2033 at 1.02%-1.00% versus 0.86% on Feb. 10. Howard County, Maryland’s new issue, 2s of 2034 at 1.44%-1.41% versus 1.43% original, while 2s of 2035 yield 1.46%.
Out longer, Washington GOs, 5s of 2041 at 1.45% versus 1.37% on Feb. 5. New YOrk City waters 5s of 2041, at 1.54% versus 1.50% Wednesday.
New York City TFA, 4s of 2049 at 1.92%-1.82% versus 2.88%-1.85% Tuesday and 1.90% original. University of Washington 5s of 2050 yield 1.58%-1.57% versus 1.52% Feb. 8.
High-grade municipals were weaker across the scale, according to final readings on Refinitiv MMD’s AAA benchmark scale. Short yields were at 0.06% in 2022 and rose two basis points to 0.12% in 2023. The 10-year rose to 0.82% and the 30-year to 1.48%.
The ICE AAA municipal yield curve showed short maturities at 0.08% in 2022 and rising two basis points to 0.14% in 2023. The 10-year rose six basis points to 0.80% while the 30-year yield rose six to 1.48%.
"The market has had a negative tone in this holiday-shortened week," said Jon Barasch, director of Municipal Evaluations at ICE Data Services said. "Even the hot high-yield market has cooled somewhat the past two days with yields backing off a bit yesterday and today."
The IHS Markit municipal analytics AAA curve showed yields at 0.10% in 2022 and plus one basis point to 0.11% in 2023 while the 10-year rose five to 0.76% and to 30-year rose four to 1.44%.
The Bloomberg BVAL AAA curve showed yields at 0.07% in 2022 and up one basis point to 0.11% in 2023, while the 10-year rose four basis points to 0.78%, and the 30-year yield rose six basis points to 1.48%.
The three-month Treasury note was yielding 0.09%, the 10-year Treasury was yielding 1.29% and the 30-year Treasury was yielding 2.08% near the close. Equities were down on the day with the Dow falling 71 points, the S&P 500 off 0.26% and the Nasdaq down 0.48%.
Gary Siegel contributed to this report.
