Municipals were a little firmer in some spots while Treasuries rallied across the board, with yields falling double-digits following the Federal Reserve hiking rates 25 basis points. Equities ended up.
“Investors are acknowledging that the Fed is nearing the end of its rate tightening cycle which is supporting a relief rally in stocks and lower bond yields, said Bryce Doty, senior vice president at Sit Investment Associates. “We agree and expect the Fed to only raise rates one more time given rapidly slowing core inflation. The positive market reaction is despite Powell trying to sound hawkish.”
The three-year muni-UST ratio was at 55%, the five-year at 57%, the 10-year at 64% and the 30-year at 90%, according to Refinitiv MMD’s 3 p.m. ET read. ICE Data Services had the three at 54%, the five at 57%, the 10 at 63% and the 30 at 88% at 4 p.m.
“One of our themes for 2022 was the pronounced drop in municipal volume year-over-year given the elevated levels of market volatility as the Fed launched an aggressive tightening campaign to arrest the highest inflation witnessed in 40 years,” said Jeffrey Lipton, managing director of credit research at Oppenheimer Inc.
This week’s dearth of new-issue supply, he said, is in more typical response to a scheduled Federal Open Market Committee meeting “whereby issuers are hesitant to make long-term commitments amid potentially surprising policy guidance, not that we see this as a meaningful likelihood of occurrence,” he said.
January 2023 was “one of the slowest issuance months for overall recorded January supply,” he noted.
There is still “a hang-over effect from last year and perhaps it may take some time before issuers have sufficient comfort to access the market,” he said. “A further downward migration in yields would likely open up refunding opportunities and there would be compelling motivation to lock in more attractive borrowing terms for new-money purposes.”
Expect “mid-single digit positive returns” on munis in 2023, he said.
Despite munis ending 2022 in the red due to “rising bond yields and resultant price erosion,” Lipton said, “the attractive cash-flows had created a strong ‘carry’ component to performance, providing an offset to the principal losses as well as defensive attributes ahead of a potential recession.”
He noted, this “dynamic will likely extend into 2023 with realistic opportunities for price appreciation.”
Much of the muni outperformance of Treasuries is ascribed to “very supportive technicals rooted in thinner primary supply and very present demand for product, particularly given ample reinvestment needs,” according to Lipton.
Returns this month represent the strongest January since 2009, per Bloomberg data.
“In sharp contrast to much of 2022, the new year begins with very encouraging monthly portfolio statements as there seems to be light at the end of the Fed’s tightening tunnel with technicals moving the outperformance needle,” he said.
The stronger market bias “has led the way for a long-awaited return to positive flows into municipal bond mutual funds,” with $4.8 billion being deposited over the past three weeks per Refinitiv Lipper.
With heavy demand needs continuing through February, he said “the tone should remain positive and we expect another month of favorable returns and further inflows.”
Bloomberg data shows total principal maturities, calls, and interest are around $38 billion for February, while the 30-day long-term forward supply is about $2.32 billion.
Lipton expects “this supply number to build once the FOMC meeting has concluded as we are already seeing some sizable names on the calendar.”
“Supply is expected to accelerate in March, and if technicals soften, there could be a dilution in monthly performance,” he said.
Given this, he expects “continued yield and income opportunities to support more visible inflows and overall positive performance throughout the coming months, although a divergent trajectory could come about in limited fashion.”
Inflows continued with the Investment Company Institute reporting investors added $2.942 billion to mutual funds in the week ending Jan. 25, after $2.083 billion of inflows the previous week.
Exchange-traded funds saw outflows of $788 million after $162 million of inflows the week prior, per ICI data.
Georgia 5s of 2024 at 2.20% versus 2.34% Tuesday. NYC 5s of 2024 at 2.41%-2.40%. California 5s of 2025 at 2.09%.
Triborough Bridge and Tunnel Authority 5s of 2029 at 2.12%. Anne Arundel County, Maryland, 5s of 2030 at 2.09%. Massachusetts 5s of 2031 at 2.12%.
Triborough Bridge and Tunnel Authority 5s of 2037 at 2.96%-2.95% versus 3.02% original on Friday. Kansas Development Finance Authority 5s of 2038 at 2.95%-2.97% versus 2.91% Monday and 2.91% Friday. NYC 5s of 2038 at 3.09% versus 3.05%-3.07% on 1/24.
LA DWP 5s of 2047 at 3.32% versus 3.35%-3.36% Tuesday and 3.47%-3.44% on 1/11. West Valley-Mission Community College District, Pennsylvania, 5s of 2047 at 3.24%-3.23% versus 3.31% on 1/13.
Refinitiv MMD’s scale was little changed. The one-year was at 2.27% (unch, -1bp Feb. roll) and 2.16% (unch, -1bp Feb. roll) in two years. The five-year was at 2.03% (-2, no Feb. roll), the 10-year at 2.19% (unch, no Feb. roll) and the 30-year at 3.20% (unch) at 3 p.m.
The ICE AAA yield curve was bumped one to two basis points: at 2.30% (-1) in 2024 and 2.22% (-1) in 2025. The five-year was at 2.06% (-1), the 10-year was at 2.15% (-1) and the 30-year yield was at 3.20% (-2) at 4 p.m.
The IHS Markit municipal curve was unchanged: 2.31% in 2024 and 2.16% in 2025. The five-year was at 2.06%, the 10-year was at 2.20% and the 30-year yield was at 3.18% at a 4 p.m. read.
Bloomberg BVAL was bumped up to two basis points: 2.31% (-1) in 2024 and 2.14% (-1) in 2025. The five-year at 2.08% (-2), the 10-year at 2.21% (-1) and the 30-year at 3.23% (unch).
The two-year UST was yielding 4.089% (-10), the three-year was at 3.757% (-13), the five-year at 3.485% (-13), the seven-year at 3.447% (-12), the 10-year at 3.402% (-9), the 20-year at 3.673% (-9) and the 30-year Treasury was yielding 3.559% (-7) at 4 p.m.
FOMC sees ‘ongoing increases’
In addition to a 25-basis point rate hike to bring the fed funds target rate to a range between 4.5% and 4.75%, the Federal Open Market Committee said it expects “ongoing increases.”
“The Committee anticipates that ongoing increases in the target range will be appropriate in order to attain a stance of monetary policy that is sufficiently restrictive to return inflation to 2 percent over time,” the statement proclaimed.
The latest Summary of Economic Projections, released after the prior meeting, showed officials expect rates to rise to 5.125% this year.
The panel noted in this post-meeting statement a “robust” employment situation with inflation waning but still “elevated.”
“The Committee is strongly committed to returning inflation to its 2 percent objective,” the statement noted.
Andrzej Skiba, head of U.S. Fixed Income, RBC Global Asset Management, said the statement was “a bit more hawkish than the market expected,” by suggesting at least two more rate hikes. But he felt Fed Chair Jerome Powell’s press conference “was less hawkish than expected.”
Specifically, he pointed to Powell’s belief inflation can be tamed without a major economic downturn or increase in unemployment. “Despite a major easing in financial conditions, there was no major pushback against investors’ recent optimism,” Skiba said. As a result, he noted, markets “quickly reversed initial losses.”
“The big criticism of the Fed this time last year was that it had fallen behind the curve, after being blindsided by surging inflation,” noted James McCann, deputy chief economist at abrdn. “After a series of outsized interest rate hikes, today’s more familiar feeling 25bps move shows a central bank more comfortable with where its policy stance sits at present.”
While inflation has shown signs of slowing, he said, “the job remains far from done, and the Fed continues to signal that a series on ongoing rate hikes will be needed to drag price growth to target.”
Still, McCann expects just “one more hike,” with a midyear recession to “derail its tightening cycle.”
The quarter-point hike “suggests the Fed feels it is now getting interest rates quite close to a level that it believes is ‘sufficiently restrictive,'” said Fitch Chief Economist Brian Coulton. He said the Fed will bring rates above 5% and keep them there through the year. “In other words, no pivot to rate cuts in late 2023.”
In his press conference, Powell said rates were not yet sufficiently restrictive and he was pleased that inflation is coming down without an increase in unemployment. Still, he said, “the job is not yet done” and “it would be very premature to declare victory.”
When asked if the hard part of reducing inflation is still ahead, Powell said, “we don’t know.” He doesn’t expect rate cuts this year, but added that could change if inflation comes down much faster than expected.
Jan Szilagyi, CEO and co-founder of Toggle AI, called the press conference “hawkish” because of the inflation focus. As a result, he sees a continued “standoff between the Fed and the market.”
“Whether the Fed hikes the overnight rate once more as futures believe, or potentially twice as indicated in the FOMC’s projections, the Fed is closer to the end of the current tightening cycle than the beginning,” said Phillip Neuhart, director of market and economic research at First Citizens Bank Wealth Management.
But he added, that doesn’t mean “the FOMC will be in a rush to cut rates.”
Payden & Rygel Principal and Chief Economist Jeffrey Cleveland noted, “Powell and the FOMC are increasingly at odds with the bond market.”
Before the announcement, the U.S. bond market expected a terminal rate near 5%, “and then begin reducing the overnight rate at mid-year,” he said. “Many investors are much more confident than the Fed that inflation will slow sharply this year.”
But Cleveland noted Powell’s statement that at least half of the items in core inflation are not yet decelerating.
Sit’s Doty said he found it interesting that Powell said “members of the Fed are looking for over half of the underlying non-housing components of core CPI to have inflation below 2%. Powell said that currently 56% of those components are running above the 2% target. So pretty close to the point where the Fed could have a ’cause to pause.'”
Still, he found it strange “that Powell believes the current 4.5% lower bound of the fed funds is not restrictive … partially based on the fact it can’t be since inflation is still high,” which Doty called “a simply bizarre analysis.”
He added, “rates are clearly restricting economic activity by nearly every measure.”
As for the difference of opinion between the Fed and the market, Payden’s Cleveland said, “Our view is more in line with the U.S. central bank. We see inflation moderating this year, but not as quickly as the bond market hopes/expects.”
As such, he said, “cuts in the federal funds rate are highly unlikely in 2023 given our economic outlook. Inflation is still far from the Fed’s objective and the labor market is very tight.”
A pause is possible in the second half of the year, Cleveland said, but in order for the FOMC to cut rates this year, “we’d have to see a complete meltdown in the labor market and an inflation slump.”
Primary to come:
The Fort Worth Independent School District, Texas, (Aaa///) is set to price Thursday $277.370 million of PSF-insured unlimited tax school building bonds, Series 2023. Piper Sandler.
The Colorado Housing and Finance Authority (Aaa/AAA//) is set to price Thursday $125 million of taxable single-family mortgage bonds, including $84 million of Class I bonds, 2023 Series A-1, serials 2023-2033, terms 2038 and 2049; $21 million of Class II adjustable rate bonds, 2023 Series A-2, term 2043; and $20 million of GNMA MBS Pass-Through Program, Class I bonds, 2023 Series B, term 2053. RBC Capital Markets.
Newark, New Jersey, is set to sell $35.598 million of qualified general capital improvement bonds, Series 2023, at 11:30 a.m. eastern Thursday.
The Clark County School District Finance Corp., Kentucky, (A1///) is set to sell $22.645 million of school building revenue bonds, Series of 2023, at 12 p.m. eastern Thursday.