With interest rate cut official, munis look toward more supply
The market got what it expected and can now shift attention to the week's remaining deals after Fed policy makers cut interest rates by a quarter point.
"Now that we got the Fed out of the way, the focus will pivot back toward supply," said one New York trader. "And the supply will keep coming, next week is shaping up to be a busy week once again."
The Federal Open Market Committee voted to cut the fed funds target range 25 basis points to 1.75% to 2% as “uncertainties” offset the prospects for “sustained expansion of economic activity, strong labor market conditions, and inflation near the Committee's symmetric 2% objective.”
The panel was split, with Federal Reserve Bank of Kansas City President Esther L. George and Federal Reserve Bank of Boston President Eric S. Rosengren again dissenting in favor of no change in the rate. Federal Reserve Bank of St. Louis President James Bullard, also voted against the move, arguing for a larger 50 basis point cut.
The Fed's dot plot suggests the panel will hold rates through the end of next year, then increase to 2.1% in 2021 and 2.4% in 2022.
Going forward, the Fed may find it “difficult to justify” future rate cuts, “based on the current state of the economy and upticks we are seeing in inflation figures and wage growth,” said Hugh Nickola head of fixed income at GenTrust. “This is particularly true if we see improvement on the trade war front.”
The end result could be more supply of municipal bonds, since tax-exempts have underperformed Treasuries since late July, he said.
“The fear of lower growth due to a trade war is clearly not good for municipalities over the longer term and the drop in rates this year will fuel more supply as we move into the fourth quarter.”
Goldman Sachs received the verbal award on Municipal Electric Authority of Georgia’s (A2/A/BBB+) for the project M bonds and (Baa2/BBB+/BBB+) for the project P bonds combined $714.79 million of Plant Vogtle Units 3&4 Project M bonds and Project P bonds. The 2044 maturity of project M bonds for $44.28 million are insured by Assured Guaranty Municipal Corp. and is rated AA by S&P Global ratings.
RBC Capital Markets received the written award on Sand Diego Community College District’s (Aaa/AAA/ ) $693.44 million of 2019 general obligation refunding taxable bonds.
Loop Capital received the written award on Cleveland’s (A3/A-/A-) $301.665 million of airport system revenue taxable bonds.
Morgan Stanley received the verbal award on Massachusetts Port Authority’s (A1/ /A+) $143.74 million of special facilities revenue bonds for the Bosfuel Project consisting of taxable and alternative minimum tax bonds.
University of Maryland System (Aa1/AA+/AA+) sold $107.965 million of auxiliary facility and tuition revenue refunding bonds, which were won by Citi with a true interest cost 1.5601%.
Wednesday’s bond sales
ICI: Muni funds see $1.28B inflow
Long-term municipal bond funds and exchange-traded funds saw a combined inflow of $1.282 billion in the week ended Sept. 11, the Investment Company Institute reported on Wednesday. It was the 37th straight week of inflows into the tax-exempt mutual funds and followed a revised inflow of $1.218 billion in the previous week.
Long-term muni funds alone saw an inflow of $1.220 billion after a revised inflow of $1.340 billion in the previous week; ETF muni funds alone saw an inflow of $62 million after an outflow of $122 million in the prior week.
Taxable bond funds saw combined inflows of $11.731 billion in the latest reporting week after revised inflows of $5.707 billion in the previous week.
ICI said the total combined estimated inflows from all long-term mutual funds and ETFs were $19.469 billion after revised inflows of $2.594 billion in the prior week. World funds were the biggest losers of the week, seeing $1.047 billion of outflows.
Heavy supply impacting performance
With negative returns on municipals and Treasuries for September, tax-exempts outperformed their taxable counterparts by about 65 basis points as of Sept. 16, according to Jeffrey Lipton, head of municipal and fixed income strategy at Oppenheimer & Co.
Lipton believes municipal performance would be even better if it were not for the heavier weekly calendars currently in the market.
Municipals remained soft but yields moved modestly higher as Treasury prices firmed following a flight to quality that took hold following the recent drone attack on Saudi Arabian oil facilities, he noted.
“We think that a supply-build is keeping tax-free prices from moving to higher ground,” Lipton wrote. “This week, the market is expected to receive about $10 billion of new issuance.”
Meanwhile, the current relationship between municipal and Treasury yields is impacting dealer pricing.
"As Treasury prices move higher as a flight-to-quality responds to the Saudi oil attack, muni yields continue to move up on recent supply-build," he said in an interview Wednesday morning. He noted that ratios are now "quite cheap," with the 10 and 30-year ratios at 89% and 97% respectively.
"We are close to long ratio levels that would have a more compelling interest for cross-over buyers," Lipton said. "As a result, pricing of dealer inventory has been adjusted to reflect the cheaper levels."
With the FOMC meeting and the geopolitically driven exposure to rate volatility, this week’s weightier calendar will test investor reception and could pressure dealer inventories, Lipton said.
“Although we expect demand to show up, it may be more uneven than what has been the case for much of the year,” Lipton wrote, noting that investors can be more discerning and given the wide swings in rates over a short period of time, certain structures that worked one month ago, may not currently work.
“Lower coupons such as 3s have underperformed with the back up in rates,” he said. “What came at par may now come at a discount.”
Typically, he said supply tends to lighten up ahead of an FOMC meeting out of policy uncertainty. “Both issuers and underwriters appear to be managing expectations with a strong belief that a 25 basis-point cut in the funds rate is a certainty,” Lipton said.
“We would also suggest that issuers see an opportunity to take advantage of favorable borrowing terms,” Lipton wrote. But, he added that a sustained back up in rates could keep many issuers on the sidelines, which may strengthen the technical dynamic and contribute to municipal performance.
At the same time, overall, he said municipal demand has remained strong — despite the back up in yields — as municipal bond mutual fund flows have been positive for 36 consecutive weeks.
“The pace of inflows remains strong, despite evidence of recent slowing,” he wrote. “For some time now, we have been questioning the sustainability of flow activity and since market technicals have shifted and rate volatility is more pronounced, the optics being placed on fund flows should be more focused.”
Lipton said retail investors are driving the flow activity as municipal ownership creates a strong incentive to offset the broader uncertainty and volatility associated with the equity market allocations.
“Tax efficiency and preservation of principal are keeping the retail investor engaged and we expect this dynamic to continue,” Lipton wrote.
A low corporate tax rate stemming from the Tax Cuts and Jobs Act have “diluted” the tax benefit of owning municipal bonds for institutional investors — however Lipton said they remain actively involved nonetheless.
While major summer reinvestment needs have passed, the net negative supply dynamic will continue over the next 30 days — albeit at a reduced pace, Lipton said.
According to Bloomberg, the total amount of bond calls and maturities over the next 30 days approximates $25.43 billion, and the 30-day total fixed rate supply is about $14.49 billion — resulting in a 30-day net supply of negative $10.94 billion.
Overall, Lipton said more challenging technicals are making it difficult to navigate the municipal waters.
“Last week, tax-exempts booked one of the worst weeks in recent memory with yields rising 23-24 basis points across the curve as the Trump administration is now signaling a willingness to consider a limited trade agreement with China that could lead to the unwinding of some of the existing tariffs and put an end to the intensifying retaliatory behavior between the two countries,” with the backdrop of abating domestic recessionary fears, Lipton wrote.
At the same time, the external geopolitical forces could impact investment in municipals securities, he said, but believes demand for municipals will generally remain strong through year end.
While there is ample cash waiting to be deployed, Lipton said outsized issuance could have softening impact on flow activity. “We would expect there to be intermittent outflows if there is a sustained sell-off in fixed income,” he wrote. “We are less concerned however that growing supply would significantly disrupt a positive flow trajectory given our outlook for extended product demand.”
Munis were slightly stronger on the MBIS benchmark scale, with yields falling by less than one basis point in both the 10-year and 30-year maturity. High-grades were weaker, with MBIS’ AAA scale showing yields rising by one basis point in the 10-year maturity and by three basis point in the 30-year maturity.
On Refinitiv Municipal Market Data’s AAA benchmark scale, the yield on both the 10-year muni GO and 30-year GO dropped by six basis points to 1.51% and 2.11%, respectively.
The 10-year muni-to-Treasury ratio was calculated at 85.0% while the 30-year muni-to-Treasury ratio stood at 94.8%, according to MMD.
Treasuries were mixed as most stock prices were in the red, with the exception of the Dow — which turned green after President Trump tweeted about Powell yet again. The Treasury three-month was yielding 1.962%, the two-year was yielding 1.754%, the five-year was yielding 1.666%, the 10-year was yielding 1.791% and the 30-year was yielding 2.244%.
Previous session's activity
The MSRB reported 35,809 trades Tuesday on volume of $9.58 billion. The 30-day average trade summary showed on a par amount basis of $11.15 million that customers bought $5.94 million, customers sold $3.30 million and interdealer trades totaled $1.91 million.
California, New York and Texas were most traded, with the Golden State taking 15.66% of the market, the Lone Star State taking 13.487% and the Empire State taking 9.351%.
The most actively traded security was the Bay Area Toll Authority 3s of 2054, which traded 27 times on volume of $32.27 million.
Data appearing in this article from Municipal Bond Information Services, including the MBIS municipal bond index, is available on The Bond Buyer Data Workstation. Click here for a brief tour of the Workstation.