Munis follow UST to higher yields but still outperform

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Municipal yields rose in secondary trading, being pulled higher in sympathy with overall rates despite very little issuance over the past few weeks, leaving a lot of cash still on the sidelines while inflows into municipal bond mutual funds continue.

The market treated the ongoing turmoil in Washington as a single event that won't have an impact on policy, stimulus or economic growth going forward, analysts and traders said, leaving participants to focus on technicals and a rising-rate environment.

It was inevitable that muni yields would need to rise somewhat as the U.S. Treasury 10-year broke above 1%, however participants said the supply/demand imbalance will hold municipals from increasing as quickly as Treasuries because of the massive amount of reinvestments in the pipeline and the money ready to be put to work.

"In fact, both the 5-year and 30-year municipal to UST ratios hit new trailing one-year lows Wednesday, illustrating just how much munis have outperformed," said Greg Saulnier, managing analyst at Refinitiv Municipal Market Data. "Coupled with the reflation trade taking hold in Treasuries and causing yields to rise, tax-exempt buyers have stepped back over the last two days and sellers have shown a bit more flexibility."

“The municipal market is obviously about the richest it's been historically versus Treasuries,” as municipals have not yet risen as much and continue to outperform, their taxable counterparts, a North Carolina trader said.

On Thursday, the municipal to Treasury ratios were at 67% in 10 years and 77% in 30 years, according to Refinitiv MMD. On Tuesday, the municipal to Treasury ratios were at 74% in 10 years and 81% in 30 years. Ratios were 67% in 10-years and 78% in 30-years, according to ICE Data Services. They were at 71% and 83% in 10- and 30-years Tuesday.

Despite the small correction Wednesday and Thursday, new deals saw repricings to lower yields. The $350 million New Jersey Economic Development Authority social school bonds repriced by as much as 20 basis points.

"Deals like the $350 million New Jersey EDA, which offer significantly more yield than your typical Aaa-AA credits, are continuing to get gobbled up by primary buyers until some real weekly supply figures return," Saulnier said.

“There is still a lot of pent-up demand for high-grade, high-yield and taxable supply because the market is starved for supply,” the North Carolina trader said.

Overall, municipal yields were one to four basis points higher throughout the yield curve on Thursday, the trader said.

“Some bonds are tighter and some are wider, depending where they are on the curve,” the trader said. The weakness was impacting the primary market, creating noticeable concessions on new issues, such as the New Jersey EDA school construction offering priced on Thursday, according to the trader.

“New issues are being well received and offering concessions of around 10 basis points higher in yield than where they would normally be priced,” he said.

“Overall, it was a very strong and robust start to the year, month, and week, but today is the first day in a while the market is seeing a little weakness, and taking a pause,” the trader said.

The protests in Washington, D.C., on Wednesday contributed to a sharp adjustment in Treasury yields, with the 10-year benchmark climbing to 1.078% on Thursday, after hitting its highest level since March a day earlier; however, the expectation of a rising-rate environment in general had more to do with the spike.

Going forward next week, issuance is again expected to be light, the trader said, noting it is still too early to tell if the current weakness will be short-lived.

“It depends on new issuance and whether or not there is selling pressure,” the trader said. “At these ratios and low yields, some investors might decide to sell the asset class and buy something more attractive,” if the current market technicals persist for an extended period.

“Everyone is sitting on the sidelines waiting for yields to correct, but I think we will start to get some clarity now that we will have an all-Democratic Congress,” he said.

Others were less sanguine about potential risks following the takeover of the U.S. Capitol Wednesday and subsequent headlines coming out of Washington.

“There’s heightened event risk for the next few weeks, and maybe the next year, more risk for potential violence," said Matt Fabian, partner at Municipal Market Analytics. "Does that interrupt what would otherwise be a recovery?

"You have to also consider that COVID is still getting worse every day. Things are getting worse. It’s hard to say we are in a recovery," he added. "Does this political volatility deepen the economic contraction or extend the period by which we wait for recovery?"

“Everyone thought when 2020 was over the world would go back to normal. We are seeing a light at the end of the tunnel, but I think we probably won’t see it until the middle or end of 2021,” the North Carolina trader said.

Refinitiv Lipper report $1.142 billion inflows
Weekly reporting tax-exempt mutual funds saw $1.142 billion of inflows in the week ended Jan. 6, Refinitiv Lipper reported Thursday. It followed an inflow of $1.8 billion in the previous week.

Exchange-traded muni funds reported inflows of $243.109 million, after inflows of $288.9131 million in the previous week. Ex-ETFs, muni funds saw inflows of $899.071 million after inflows of $1.478 billion in the prior week.

The four-week moving average remained positive at $1.278 billion, after being in the green at $1.240 billion in the previous week.

Long-term muni bond funds had inflows of $465.390 million in the latest week after inflows of $704.323 million in the previous week. Intermediate-term funds had inflows of $149.612 million after inflows of $140.243 million in the prior week.

National funds had inflows of $1.112 billion after inflows of $1.684 billion while high-yield muni funds reported inflows of $98.262 million in the latest week, after inflows of $228.745 million the previous week.

Primary market
RBC Capital Markets priced the City and County of Denver School District No. 1, Colo.'s (Aa1/AA+/AA+/) $450 million of general obligation refunding bonds. Bonds in 2021 with a 5% coupon yielded 0.09% (six bps lower than morning wires), 5s of 2028 at 0.59%, 5s of 2031 at 0.89% (same as a morning wire, showing the concessions around the 10-year), 3s of 2036 at 1.45% (repriced seven bps lower), 4s of 2041 at 1.47% and 4s of 2045 at 1.60%. The deal is backed by the Colorado State Intercept Program.

Loop Capital Markets priced the New Jersey Economic Development Authority’s (Baa1/BBB/BBB+/NR) $350 million of Series 2021 QQQ school facilities construction social bonds. Bonds in 2022 with a 5% coupon yielded 0.59% (down from 0.74% in a morning wire), 5s of 2026 yielded 0.96% (down 15 bps), 5s of 2031 at 1.66% (down 20 bps), 4s of 2036 at 2.27% (down 20 bps), 4s of 2041 at 2.47% (down 20 bps) and 4s of 2050 at 2.70% (also down 20 bps).

Wells Fargo Securities priced the California Infrastructure and Economic Development Bank’s $299 million of refunding revenue bonds for the Los Angeles County Museum of Art project. Bonds mature in December 2050 with a 1.2% coupon priced at par. $71 million mature in December 2050 with a 0.77% coupon priced at par.

Secondary market
High-grade municipals were weaker by two basis points on bonds 2026 and out, according to final readings on Refinitiv MMD’s AAA benchmark scale. Short yields were steady at 0.13% in 2022 and 0.14% in 2023. The 10-year rose two basis points to 0.74% and the 30-year rose to 1.43%.

The ICE AAA municipal yield curve showed short maturities flat at 0.13% in 2022 and at 0.15% in 2023. The 10-year maturity rose two basis points to 0.72% while the 30-year yield was at 1.44%.

The IHS Markit municipal analytics AAA curve showed yields at 0.14% in 2022 and 0.15% in 2023 while the 10-year was at 0.69% and the 30-year yield was at 1.39%.

The three-month Treasury note was yielding 0.09%, the 10-year Treasury was yielding 1.08% and the 30-year Treasury was yielding 1.85%. The Dow rose 250 points, the S&P 500 rose 1.65% and the Nasdaq rose 2.71%.

COVID and consumer habits
The coronavirus may have permanently changed consumer habits, according to Federal Reserve Bank of Philadelphia President Patrick T. Harker.

“I expect that, as we recover, the economic picture will remain uneven, with wildly unequal outcomes across sectors of the economy,” he said in a virtual speech, according to prepared text released by the Fed. “There’s a strong chance that consumer habits will have changed long term, even when we’ve finally rid ourselves of COVID-19. That will have significant impacts.”

Video could take the place of business travel “indefinitely,” he suggested, which would impact hotels and restaurants, while increased online shopping would be negative for “the physical retail industry,” Harker said. “And higher education ― my old industry ― faces major threats not only from changes brought on by the pandemic, but also from the country’s demographics. The traditional college-age population has actually begun to decline.”

Declines in these sectors would, in turn, reach other parts of the economy, such as “commercial real estate. And a downturn in commercial real estate would, of course, affect the financial industry … et cetera, et cetera.”

Economic data released Thursday included initial jobless claims, which dipped to 787,000 in the week ended Jan. 2 from an upwardly revised 790,000 in the week ended Nov. 26, first reported as 787,000.

Continued claims fell to 5.072 million in the week ended Nov. 26 from 5.198 million in the week ended Nov. 19.

Separately, the international trade deficit widened to $68.1 billion in November from $63.1 billion in October.

Economists polled by IFR Markets expected a $64.5 billion shortfall.

The Institute for Supply Management’s December services PMI index rose to 57.2 from 55.9 in November. Economists expected a 54.6 read.

The business activity/production index rose to 59.4 from 58.0, new orders grew to 58.5 from 57.2, but employment slid to 48.2 from 51.5.

Christine Albano contributed to this report.

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Primary bond market Secondary bond market Treasury bonds New Jersey Economic Development Authority Economic indicators Federal Reserve Bank of Philadelphia Patrick Harker Federal Reserve FOMC
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