Munis steady, UST yields rise after GDP report

Municipals were steady Thursday in the secondary market while an $830 million deal from the Triborough Bridge and Tunnel Authority took focus in the primary.

U.S. Treasuries yields rose after the fourth-quarter gross domestic product report was better than expected and equities ended up.

The three-year muni-UST ratio was at 54%, the five-year at 57%, the 10-year at 63% and the 30-year at 88%, according to Refinitiv MMD’s 3 p.m. ET read. ICE Data Services had the three at 54%, the five at 58%, the 10 at 64% and the 30 at 89% at 4 p.m.

On the buy side, lower interest rates and an extreme imbalance between supply and demand is supporting the municipal market’s positive tone as the first month of 2023 soon comes to a close, according to JB Golden, executive director and portfolio manager at Advisors Asset Management.

“Municipals are off to a good start in 2023 with the broad market” up 2.86% as of Wednesday, he noted. 

The decline of the 10-year Treasury bond by roughly 40 basis points since the beginning of January has been a tailwind for fixed income in general, Golden said.

“Municipals are outpacing Treasuries by 25 basis points on a relative basis 25 days into 2023, which likely reflects the lack of supply relative to increasing demand,” he said on Wednesday.

Part of that is explained by the January effect — a seasonal phenomenon characterized by low supply and elevated reinvestment demand — being more severe than many market experts originally predicted, according to Golden.

“We are on a 14-day streak of inflows and — anecdotally on the managed account side — we are seeing significant interest in tax-exempt municipals to start the new year,” he added.

At the same time, the market has been dealing with constrained supply since late last year, which is reflected” in tightening muni-UST ratios, he said.

A good portion of that has come in January, he said, as demand has picked up with no relief coming on the supply side.

Historically, Cooper Howard, a fixed income strategist focused on munis at Charles Schwab, said, “January has been the best month for total returns on average for munis, and this month is shaping up to be another great month.”

“The performance is being led by the longer-term and lower-rated portions of the market,” he said.

Taxable munis are outperforming in part “due to their longer durations and valuations were attractive coming into the year,” according to Howard.

The strong performance has resulted in very rich valuations, he said. The 10-year muni-UST ratio is at 64%, per ICE, the lowest since July 2021.

“Relative yields are even more rich for the short end of the curve” with the two-year at 53%, per ICE, versus a five-year average of 87%.

“We would not be surprised if the positive momentum in total returns slows because historically, when relative yields are very rich, munis underperform Treasuries over the next year,” he said.

Moreover, history suggests that “2023 could be a good year for the municipal bond market as yields and fundamentals should once again drive total return,” said Thornburg portfolio managers Eve Lando, John Bonnell and David Ashley.

Even during the pandemic, they said, “personal income, property and sales tax revenue all performed well, exceeding expectations in some cities, counties and states, while federal stimulus money and internet sales tax revenues added billions to municipal coffers.”

However, “with an economic slowdown looming and the federal stimulus spigot about to turn off, municipal revenues and overall credit quality have likely reached a peak for the current cycle,” they noted.

Over the last 30 years, “90% of the total return of the broad market index has been attributable to income and only 10% to price returns,” according to the Thornburg portfolio managers.

“Considering income is the only component of total return that is tax-exempt for municipal investors, it becomes even more attractive when adjusted for federal tax rates,” they said.

They expect a “return to normalcy” with income as “the primary driver of total return going forward for the asset class, yields will remain in more normal ranges driven by the end of the Fed[eral Reserve]’s zero interest rate policy and municipal issuers will be resilient in an economic slowdown while defaults remain rare.”

Heading into February, Golden said he is being cautious — even though yields are attractive and the market is displaying strength so far in the first month of the year.

“It is hard not to like municipals over the longer horizon given that yields are back, credit fundamentals are strong, corporate earnings are beginning to weaken, and concern remains that we could be heading for a recession,” he explained. 

But, Golden said he will remain cautious on adding too much credit or interest rate risk at current valuations, Golden added. 

“The Fed and the bond market seem to be at odds right now as to the direction of monetary policy, with bond markets pricing in FOMC cuts by year end and Fed officials jaw-boning Fed Funds will remain above 5%,” he said.  

As a result, Golden is recommending being cautious overall until there is more clarity on both supply and monetary policy.

Inflows continued, as Refinitiv Lipper reported $1.277 billion was added to municipal bond mutual funds in the week ending Wednesday after $1.511 billion of inflows the week prior.

High-yield saw $652.279 million of inflows after $822.556 million of inflows the week prior, while exchange-traded funds saw outflows of $610.812 million after $143.697 million of inflows the previous week.

In the primary market Thursday, Jefferies priced for the Triborough Bridge and Tunnel Authority (/AA-//AA/) $829.560 million of general revenue refunding bonds, Series 2023A, with 5s of 2024 at 2.49%, 5s of 2028 at 2.30%, 4s of 2028 at 2.30%, 5s of 2033 at 2.47%, 5s of 2038 at 3.10% and 4s of 2039 at 3.67%, callable 5/15/2033.

Siebert Williams Shank priced for the Spring Independent School District, Texas, (Aa2/AA-//) $297.945 million of unlimited tax school building bonds, Series 2023, with 5s of 8/2024 at 2.37%, 5s of 2028 at 2.23%, 5s of 2033 at 2.48%, 5s of 2038 at 3.21%, 5s of 2043 at 3.93%, 5s of 2047 at 3.67% and 4s of 2052 at 4.17%, callable 8/15/2033.

In the competitive, the Spartanburg County School District 5, South Carolina, (Aa1/AA//) sold $100 million of GOs, Series 2023 (South Carolina School District Credit Enhancement Program), to BofA Securities, with 5s of 3/2024 at 2.25%, 5s of 2028 at 2.08%, 5s of 2033 at 2.26%, 5s of 2038 at 2.95%, 4s of 2043 at 3.75% and 4s of 2046 at 3.81%, callable 3/1/2032.

Secondary trading
Ohio 5s of 2024 at 2.21% versus 2.21% Tuesday. NYC TFA 5s of 2024 at 2.38%. Georgia 4s of 2025 at 2.17% versus 2.24% Tuesday.

Loudoun County, Virginia, 5s of 2028 at 2.09%. Tennessee 5s of 2029 at 2.09%. Georgia 5s of 2030 at 2.12% versus 2.12% Wednesday and 2.14%-2.15% Friday.

Washington 5s of 2037 at 2.90% versus 2.91% Wednesday and 2.93%-2.91% Friday. DC 5s of 2038 at 2.96% versus 2.97% Wednesday and 3.00%-2.94% Monday. Austin ISD 5s of 2039 at 3.13%-3.10% versus 3.04%-3.05% Wednesday and 3.10% original on 1/19.

San Jose Financing Authority, California, 5s of 2047 at 3.26% versus 3.37% on 1/11 and 3.43%-3.44% on 1/9. LA DWP 5s of 2052 at 3.37% versus 3.37% Tuesday and 3.62%-3.60% on 1/9. Illinois Finance Authority 5s of 2052 at 4.08%-4.09% versus 4.32%-4.26% on 1/11 and 4.40% on 1/9.

AAA scales
Refinitiv MMD’s scale was unchanged. The one-year was at 2.33% and 2.17% in two years. The five-year was at 2.05%, the 10-year at 2.19% and the 30-year at 3.18% at 3 p.m.

The ICE AAA yield curve was bumped a basis point: at 2.28% (-1) in 2024 and 2.21% (-1) in 2025. The five-year was at 2.07% (-1), the 10-year was at 2.17% (-1) and the 30-year yield was at 3.21% (-1) at 4 p.m.

The IHS Markit municipal curve saw cuts on the front end: 2.33% (+1) in 2024 and 2.16% (+3) in 2025. The five-year was at 2.06% (unch), the 10-year was at 2.18% (unch) and the 30-year yield was at 3.16% (unch) at a 4 p.m. read.

Bloomberg BVAL was little changed: 2.32% (unch) in 2024 and 2.15% (unch) in 2025. The five-year at 2.10% (unch), the 10-year at 2.22% (+1) and the 30-year at 3.21% (unch).

Treasuries were weaker.

The two-year UST was yielding 4.191% (+6), the three-year was at 3.890% (+5), the five-year at 3.597% (+4), the seven-year at 3.553% (+6), the 10-year at 3.494% (+5), the 20-year at 3.758% (+4) and the 30-year Treasury was yielding 3.628% (+3) at 4 p.m.

Fourth-quarter gross domestic product, increased at a 2.9% annualized rate, slightly higher than economists’ expectations, but analysts don’t expect the strength to last.

“The U.S. economy continued to expand at a robust rate in the fourth quarter,” said Morning Consult chief economist John Leer. But the lion’s share was “fueled by a shockingly resilient consumer, but we’ve started to see that resilience wane more recently.”

Inflation has hit consumers, who have had to turn to savings or credit to make ends meet, Leer said. “With consumer demand likely to continue its downward trajectory, business investment is also likely to slow in the coming quarters, increasing the probability of a recession this year.”

While the headline number beat expectations and was only modestly down from the third quarter figure, Wells Fargo Securities Chief Economist Jay Bryson noted the underlying components were not quite as impressive.

“Real personal consumption expenditures grew at a solid annualized rate of 2.1% in Q4,” Bryson said. “But fixed investment spending fell 6.7% as business investment in equipment declined 3.7% and residential investment nosedived at an annualized rate of 26.7%.”

Furthermore, he noted “the 2.9% growth rate for the entire quarter obscures the underlying dynamics of the economy as the quarter progressed.”

The strength of the data came from inventory building, said ING Chief International Economist James Knightley. “Our concern is that the inventory building is increasingly involuntary rather than planned — consumer demand is softening at a time when improved supply chains have boosted the stock of products available,” Knightley said. “Likewise, the improvement in net trade is down to imports falling (a sign of a weakening U.S. demand outlook) rather than exports rising.”

“We have good growth but not for great reasons,” he said.

The report boosts the chances of a soft landing, said Alexandra Wilson-Elizondo, head of Multi-Asset Retail Investing at Goldman Sachs Asset Management, but “the emphasis should remain on the tightness of the labor market, as evidenced by initial jobless claims.”

It is difficult to “see unemployment rising to the required rate to moderate wage inflation at these levels of growth,” she said.

The numbers — above average growth and low jobless claims — “should challenge the view of a policy pivot in the near term,” Wilson-Elizondo said.

“We need activity weakness to translate to job losses to address [Fed Chair Jerome] Powell’s preferred services ex-shelter inflation metric, where wages are the primary driver,” Wilson-Elizondo said. “We continue to think that we should not fight the Fed because they will demonstrate a slow reaction function on inflationary risk management.”

Going forward, Wells Fargo’s Bryson said, “This loss of momentum at the end of the fourth quarter means that the solid growth rates that the U.S. economy posted in the second half of 2022 likely will not be repeated in the first quarter.” The firm sees real GDP “more or less flat in Q1 023 on a sequential basis.”

Others agreed with Bryson’s assessment.

“While 4Q22 marked a modest step down from 3Q, we expect to see more significant slowing into 1Q23 as the cumulative effect of tighter monetary policy begins to push growth below potential,” said Morgan Stanley economists. They expect first quarter GDP to be up 0.2%.

The report eased recession fears, said José Torres, senior economist at Interactive Brokers.

“The strong growth, however, is creating additional headwinds for curtailing inflation that could cause the Federal Reserve to double-down on its hawkish stance against persistent price increases,” he said. “The robust number is not supporting this year’s strong rotation into growth stocks by equity investors who are anticipating that interest rates won’t climb as high as previously thought.”

Mutual fund details
Refinitiv Lipper reported $1.277 billion of inflows for the week ended Wednesday following $1.511 billion of inflows the previous week.

Exchange-traded muni funds reported outflows of $610.812 million after inflows of $143.697 million in the previous week. Ex-ETFs, muni funds saw inflows of $1.887 billion after inflows of $1.367 billion in the prior week.

Long-term muni bond funds had inflows of $924.075 million in the latest week after inflows of $1.478 billion in the previous week. Intermediate-term funds had inflows of $312.132 million after inflows of $185.112 million in the prior week.

National funds had inflows of $1.233 billion after inflows of $1.377 billion the previous week while high-yield muni funds reported inflows of $652.279 million after inflows of $822.556 million the week prior.

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