Municipals take back seat as Fed hikes rates

Bonds

After the Federal Reserve hiked interest rates for the first time since 2018 and said it would raise them six more times this year, U.S. Treasury yields continued to rise, while munis were relatively stable and equities rallied to close the session.

Municipal to UST ratios showed the five-year at 76%, 90% in 10-years and 97% in 30, according to Refinitiv MMD’s 3 p.m. read. ICE Data Services had the five at 78%, the 10 at 95% and the 30 at 99% at a 4 p.m. read.

Trading was mixed ahead of the Fed’s announcement but a few blocks traded post-FOMC. Howard County, Maryland 5s of 2030 at 1.96% and 5s of 2031 at 2.01%. Their original levels were 1.48% and 1.52%, respectively, when it priced the first week of March.

The Investment Company Institute on Wednesday reported $2.258 billion of outflows in the week ending March 9, down from $3.502 billion of outflows in the previous week.

Exchange-traded funds saw inflows at $617 million versus $92 million of inflows the week prior.

Bidders align projected FOMC actions/comments with internal fundamentals as the corrective phase continues.

The 10-year triple-A muni is on the verge of trading back behind 2%, a level that has traditionally attracted individual buyers, said Kim Olsan, senior vice president at FHN Financial.

Olsan said rates are being weighed down by an acceleration of some measures, including fund outflows, swaying — but rising — ratios, and tax seasonals.

Benchmark cuts in recent months indicate a higher premium for those investing in funds and demanding more concessions, perhaps indicating a near-oversold scenario. With less connection between munis and USTs, she said inventory carry has proven risky in a turbulent news cycle — every trading day in March has brought wider muni yields.

Refinitiv MMD’s five-year has risen 39 basis points since March 1, the 10-year has risen 45 and the 30-year 46 since the start of the month.

With the new issue calendar this week cutting back on volume, she said secondary selling has become more of a fixture in daily yield movements.

Tuesday’s bids wanted hit $1.492 billion, marking the 21st session over $1 billion.

“If there’s any cohesive theme to bid lists it’s that of short maturity/short call structures — where the roll-off yield is minimal on the seller’s side and defensive bidding is picking up the slack,” she said. “Trading in state-level names with 10-year finals and two-year calls near 2% has a large value proposition attached to it — near 100% ratio to USTs to the call date with comparable yields to longer call protected bonds.”

In a world where there is more uncertainty, the safety of a short-term bond has gained popularity, she said.

She said the FOMC’s rate hike will provide further insight into rate expectations in the coming months. Fund flow reports will play an almost equal role in the supply/demand equation.

Puerto Rico
On Tuesday, Puerto Rico completed the exchange of more than $33 billion of existing bonds and other claims into $7 billion of new bonds, as the commonwealth began repaying bondholders for the first time since it defaulted on its debt in 2016.

Bondholders were free to trade the bonds as soon as they received them. On Wednesday, block trading showed weaker prints: Puerto Rico GO 5.25s of 7/2023 at 2.84-3.25% ($102.50-$103.00) in six trades versus 2.30%-3.03% ($102.76-$103.71) in 16 trades Tuesday.

Puerto Rico GO 5.375s of 7/2025 at 2.92% ($107.62) in one trade versus 2.69%-2.94% ($107.58-108.36) in six trades Tuesday.

Puerto Rico GO 5.625s of 7/2027 at 2.99%-3.58% ($112.50-$112.79) in five trades versus 2.94%-3.04% ($112.56-$113.01) in six trades Tuesday.

Puerto Rico GO 5.625s of 7/2029 at 3.08%-3.10% ($116.33-$116.47) in two trades versus 3.08%-3.10% ($116.36-$116.47) in two trades Tuesday.

Puerto Rico GO 5.75s of 7/2031 at 3.32%-3.40% ($118.56-$119.25) in two trades versus 3.35% ($119.02) in one trades Tuesday.

Puerto Rico 0s of 11/2043 at ($55.00-$56.75) in eight trades versus ($57.00-$57.25) in seven trades Tuesday.

Puerto Rico GO (74514l3P) 4s of 7/2046 at 4.14%-4.25% ($96.23-$97.84) in nine trades versus 4.06%-4.11% ($98.25-$99.07) in 23 trades Tuesday.

Secondary trading
Prior to the FOMC meeting, secondary trading was busy.

Guilford County, North Carolina 5s of 2025 at 1.61%-1.62%. Minnesota 5s of 2025 at 1.61%. Arlington County, Virginia 5s of 2026 at 1.66-1.69%. New York Dorm Cornell 5s of 2026 at 1.69% versus 1.69%-1.71% Tuesday.

DASNY 5s of 2027 at 1.97%. Maryland 5s of 2027 at 1.83-1.84%. District of Columbia 5s of 2028 at 1.83%. North Carolina 5s of 2028 at 1.87%-1.88% versus 1.83% Monday.

Baltimore County, Maryland 5s of 2030 at 1.97%. Baltimore County, Maryland 5s of 2031 at 2.00%-2.04%. Baltimore County, Maryland 5s of 2032 at 2.07%.

California 5s of 2037 at 2.48% versus 2.33% on Thursday. Ohio 5s of 2039 at 2.35%-2.36%. California 5s of 2041 at 2.58%-2.62% versus 2.57%-2.58% Monday.

California 5s of 2047 at 2.68%-2.69% versus 2.73%-2.74% Tuesday. LA DPW 5s of 2047 at 2.69%-2.70% versus 2.69% Monday and 2.55%-2.57% Friday. NYC Municipal Water Finance Authority 5s of 2052 at 2.92%-2.93% versus 2.84%-2.86% Monday.

After the Fed’s quarter-point rate hike, trading was light.

Hawaii Harbor system revs 5s of 2029 at 2.14%. Howard County, Maryland 5s of 2030 at 1.96% and 5s of 2031 at 2.01%. Their original levels were 1.48% and 1.52%, respectively. Triborough Bridge and Tunnel Authority 5s of 2051 at 2.93%-2.94%.

AAA scales
Refinitiv MMD’s scale was unchanged at the 3 p.m. read: the one-year at 1.16% and 1.42% in two years. The five-year at 1.69%, the 10-year at 1.98% and the 30-year at 2.39%.

The ICE municipal yield curve was cut one to three basis points: 1.15% (+3) in 2023 and 1.48% (+3) in 2024. The five-year at 1.70% (+2), the 10-year was at 2.04% (+1) and the 30-year yield was at 2.44% (+1) in a 4 p.m. read.

The IHS Markit municipal curve was also cut: 1.16% (+1) in 2023 and 1.43% (+1) in 2024. The five-year at 1.70% (+1), the 10-year at 1.99% (+1) and the 30-year at 2.39% (+1) at a 4 p.m. read.

Bloomberg BVAL saw one basis point cuts: 1.14% (unch) in 2023 and 1.40% (+1) in 2024. The five-year at 1.69% (+1), the 10-year at 1.98% (+1) and the 30-year at 2.38% (unch) at a 4 p.m. read.

Treasuries were weaker while equities rallied.

The two-year UST was yielding 1.913%, the five-year was yielding 2.166%, the seven-year 2.209%, the 10-year yielding 2.180%, and the 30-year Treasury was yielding 2.452% at the close. The Dow Jones Industrial Average gained 518 points or 1.55%, the S&P was up 2.24% while the Nasdaq gained 3.77% at the close.

We have liftoff
The Federal Open Market Committee did what was expected: it raised the fed funds rate target 25 basis point to a range on 0.25% to 0.50%, it upped its projections for future rate hikes and inflation and cut growth estimates.

The Fed also said it expects to address runoff of securities from its nearly $9 trillion balance sheet at “a coming meeting,” having made progress in its discussions at this meeting. In his press conference, Fed Chair Jerome Powell said a decision could be reached at the next meeting and while it “will look familiar,” it will be faster and sooner than the last quantitative tightening.

Federal Reserve Bank of St. Louis President James Bullard dissented as he favored a 50-basis-point rate hike at this meeting. In his press conference, Powell said faster rate hikes at future meetings “are certainly a possibility.”

“There is no ‘shock and awe’ in the initial move on interest rates today, but the balance sheet run off is going to start earlier than expected and the dot plot suggests another 150 bps of hikes to come this year and another 100 bps in 2023,” said Brian Coulton, Fitch Ratings chief economist. “The key change in the text is the acknowledgment of ‘broader price pressures’.”

The Fed plans to get rates to a neutral level, or slightly higher, by the end of 2023, he said. “This is a big change from the December projections and reflects the recent acceleration in wages and rents and the adverse supply shock from the Russia Ukraine war.”

The Summary of Economic Projections suggested the fed funds target rate could approach 2% this year, with five participants seeing rates between 1.75% and 2%, three each expecting a 2.25% to 2.5% level and a 1.5% to 1.75% rate, two expect a 2% to 2.25% range, while one member expects a 1.25% to 1.50% rate, one sees rates rising to between 2.50% and 2.75% and one FOMC panelist sees a 3% to 3.25% rate by yearend.

“The Fed, much criticized for misreading inflation, delivered what was expected in its March FOMC meeting: a 25-basis point hike, the first increase in interest rates since 2018,” said Christian Scherrmann, U.S. Economist at DWS Group. “But the central bank suggested much more monetary tightening was to come, showing more determination to do what it takes to tackle inflation than markets expected.”

“Overall, the Fed has repositioned itself as an inflation-fighting institution and has surprised significantly on the hawkish side.”

All members see rates ending next year above 2%, with one dot at 2% to 2.25%, four 25 basis points higher, three each at 2.50% to 2.75% and 2.75% to 3%, two at 3% to 3.25% and one 25 basis points higher, with the last two dots at 3.50% to 3.75%.

Personal consumption expenditure inflation projections grew to 4.3% for this year from 2.7% in December’s projections and bumped to 2.7% next year from 2.3% and to 2,3% from 2.1% for 2024.

GDP projections for this year were cut to 2.8% from 4% in the last SEP, while staying at 2.2% for next year and 2.0% for 2024. Unemployment remained at 3.5% this year and next, ticking up 0.1-point to 3.6% in 2024.

“The Fed has abandoned mentions of COVID and in its place rightfully added concerns about energy, Ukraine/Russia and even more ink on inflation,” noted Jason Brady, president & CEO at Thornburg Investment Management.

“Inflation is becoming entrenched in the U.S. economy,” he said. “The Fed is going to be forced to choose between a hard landing and entrenched inflation. Today’s forecast and statement unsurprisingly fails to recognize these binary outcomes.”

The rate hike, Brady said, “is too small to matter right now,” and the “guidance on the balance sheet falls short.” He’s worried they will choose to go on “autopilot” as they did in 2018, which, he said, “was a mistake.”

Morning Consult Chief Economist John Leer noted, “The Fed is counting on a strong labor market to fuel the economy through the end of the year.”

If the war in Ukraine has “spillover effects on U.S. jobs,” he said, it “would put the Fed in a particularly challenging position later this year.”

But Powell shrugged off the chance of recession, saying the probability was “not elevated.” Economic strength, he said, “can flourish in the face of less accommodative monetary policy.”

When asked if the Fed was behind the curve, Powell would not answer. But, he admitted that if the Fed knew what it knows now about how supply chains and inflation would move during the pandemic, “in hindsight, we would have raised rates earlier.”

“Chairman Powell spoke in a measured tone under very difficult circumstances due to the terrible turmoil in Ukraine, high inflation, tight labor market and a COVID epidemic, which hopefully will dissipate,” said John Farawell, managing director and head of municipal trading at Roosevelt & Cross. “The Treasury curve and its inversion also signals future economic issues when these other issues play out.”

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