Yields fall to close out March, but munis end Q1 deep in the red

Bonds

Municipals were better Thursday as triple-A benchmark yields fell while U.S. Treasuries were mostly steady and equities ended down.

Triple-A municipal yield curves saw one to four basis point bumps. . Muni to UST ratios were at 82% in five years, 94% in 10 years and 104% in 30, according to Refinitiv MMD’s 3 p.m. read. ICE Data Services had the five at 79%, the 10 at 96% and the 30 at 105% at 4 p.m.

Investors pulled more from municipal bond mutual funds in the latest week, with Refinitiv Lipper reporting $2.038 billion of outflows, up from $1.503 billion of outflows in the previous week.

Exchange-traded muni funds reported inflows of $372.255 million after inflows of $126.536 million the previous week while high-yield saw outflows to the tune of $485.719 million after $10.501 million of inflows the week prior.

Municipals will end the month and the first quarter of 2022 deep in the red. The Bloomberg Muni Index has posted negative 3.41% returns in March and losses of 6.39% year to date. High-yield is showing 3.79% losses for March and 6.70% for 2022 while taxables have lost 5.32% month-to-date and 8.56% in 2022 so far. Bloomberg’s Impact Index is showing 4.34% losses for March and 8.07% year-to-date.

In the primary Thursday, Ramirez & Co. priced for the Virgin Islands Matching Fund Special Purpose Securitization Corp. (///BBB) $955.545 million of Matching Fund Securitization bonds. The first tranche, $933.785 million of bonds, Series 2022A, saw bonds in 10/2025 with a 5% coupon yield 4.05%, 5s of 2027 at 4.25%, 5s of 2032 at 4.522% and 5s of 2039 at 4.73%, callable in 10/1/2032.

The second tranche, $21.760 million of taxable bonds, Series 2022B, saw bonds in 10/2025 with a 6% coupon price at par, make whole call.

Citigroup Global Markets priced for Idaho Housing and Finance Association (Aa1//AA+/) $185.740 million of Transportation Expansion and Congestion Mitigation Fund sales tax revenue bonds, Series 2022A. Bonds in 8/2023 with a 5% coupon yield 1.82%m 5s of 2027 at 2.22%, 5s of 2032 at 2.55%, 5s of 2037 at 2.76%, 5s of 2042 at 2.88% and 5s of 2047 at 3.00%, callable in 8/15/2032.

In the competitive market, Louisville-Jefferson County Metro Government, Kentucky (Aa1//AAA/) sold $228.305 million of general obligation bonds, Series 2022A, to BofA Securities. Bonds in 4/2023 with a 5% coupon yield 1.60%, 5s of 2027 at 2.07%, 5s of 2032 at 2.32%, 4s of 2037 at 2.76% and 4s of 2042 at 2.84%, callable in 4/1/2032.

Montgomery County, Tennessee (Aa2/AA//) sold $118.680 million of general obligation bonds, Series 2022A, to Piper Sandler & Co. Bonds in 4/2023 with a 5% coupon yield 1.65%, 5s of 2027 at 2.11%, 5s of 2032 at 2.34%, 3s of 2037 at 3.08%, 3.25s of 2042 at 3.30% and 3.25s of 2044 at 3.36%, callable in 4/1/2031.

Continued stability helped prop up the municipal market on Thursday, a day before the arrival of the second quarter.

“The municipal bond market today has a more constructive feel to it as it seems to be trying to form a short-term bottom,” Michael Pietronico, president and chief executive officer at Miller Tabak Asset Management, said Thursday.

“Absolute yields have moved up to levels that are much more competitive versus other asset classes, which bodes well for a positive start for April,” he said.

Should a floor develop in prices causing mutual fund redemptions to slow investors may be surprised how quickly municipal yields stabilize, and potentially fall in small increments, Pietronico said.

“The market is oversold as most of the fixed-income class is so investors should not expect a repeat of the first quarter’s dismal returns in the coming months,” he said.

Finally seeing a little stability has been a relief to investors of the municipal market, according to Matthew Gastall, executive director and head of wealth management municipal research and strategy at Morgan Stanley.

Municipals have a laggard response to the volatility so mutual fund outflows may continue until sustained Treasury stability continues, he said.

“In past periods in 2013, 2016, and 2018 we did see quick outperformance of munis to Treasuries once stability ensued,” Gastall said, noting the outperformance was due to municipals’ high coupon structures, tax efficiencies, and wealth preservation.

“We did see that in past periods and it is notable moving forward,” he said.

If rates rise and supply is healthy, Gastall recommends putting money to work and focusing on above market coupon structures, kicker bonds with short calls. “It’s not a question of investing but what to invest in,” he said.

Investors can currently earn 80% of the yield curve in five years, with a lot of the value up front on the curve.

For investors who want to extend, Gastall strongly advocates a kicker structure, mostly because of the high coupons and relatively short calls.

“The dollar price tends to be anchored lowered to that call option, so that call option means you could be reinvesting at higher rates or the yield can kick up higher and help investors keep pace with higher rates,” he noted.

Overall, Gastall said he is keeping an eye on Friday’s jobs number, as well the broader economy and geopolitical impacts of oil prices and inflation.

“Supply has been manageable and that will continue,” he said. “Now after the rate moved higher, a lot of the taxable refinancings are out of the money, and we’re back to seeing a portion of tax-exempt supply return.”

Municipal issuance fell 17.6% year-over-year in March led in part by a drop in refunding volumes amid market volatility and a rising-rate environment, but the total $39.4 billion figure is above the $34.363 billion 10-year average.

Thirty-day visible supply is at $16.11 billion, per Bond Buyer. Gastall expects a healthy calendar in April and May as typically the municipal market experiences ahead of summer redemption season.

“There are a lot of things that could create more opportunity over the next few months, and we will see if munis outperform once we see more stability,” he said. “We are keeping an eye out for more value in the next quarter.”

Mutual funds see outflows
In the week ended March 30, weekly reporting tax-exempt mutual funds saw investors pull more money out with Refinitiv Lipper reporting $2.038 billion of outflows Thursday, following an outflow of $1.503 billion the previous week.

Exchange-traded muni funds reported inflows of $372.255 million after inflows of $126.536 million in the previous week. Ex-ETFs, muni funds saw outflows of $2.411 billion after $1.630 billion of outflows in the prior week.

The four-week moving average dropped to negative $1.584 billion from negative $1.781 billion from in the previous week.

Long-term muni bond funds had outflows of $1.008 billion in the last week after outflows of $629.576 million in the previous week. Intermediate-term funds had outflows of $583.351 million after $427.171 million of outflows in the prior week.

National funds had outflows of $1.727 billion after $1.289 billion of outflows the previous week while high-yield muni funds reported $485.719 million of outflows after $10.501 million of inflows the week prior.

Secondary trading
North Carolina 5s of 2023 at 1.60%. Utah 5s of 2024 at 1.77%-1.76%. Maryland 5s of 2024 at 1.80%-1.65% versus 1.68% a week ago. Minnesota 5s of 2026 at 2.00% versus 2.11% Monday.

Prince George’s County, Maryland 5s of 2027 at 2.03%-2.04%. North Carolina 5s of 2028 at 1.79%-1.77%. California 5s of 2029 at 2.17% versus 2.40%-2.37% Tuesday.

New York City 5s of 2036 at 2.76% versus 2.95% Monday and 2.85% original. New York City waters 5s of 2051 at 3.01%-3.00% versus 3.24%-3.23% Tuesday. Los Angeles DWP 5s of 2051 at 2.84%-2.81%.

AAA scales
Refinitiv MMD’s scale was bumped three to four basis points at the 3 p.m. read: the one-year at 1.55% (-3) and 1.76% in two years (-3). The five-year at 1.97% (-4), the 10-year at 2.18% (-4) and the 30-year at 2.53% (-4).

The ICE municipal yield curve was bumped two to four basis points: 1.53% (-3) in 2023 and 1.80% (-2) in 2024. The five-year at 1.95% (-3), the 10-year was at 2.21% (-4) and the 30-year yield was at 2.59-% (-4) in a 4 p.m. read.

The IHS Markit municipal curve was bumped: 1.52% (-3) in 2023 and 1.74% (-3) in 2024. The five-year at 1.99% (-3), the 10-year at 2.19% (-3) and the 30-year at 2.59% (-3) at a 4 p.m. read.

Bloomberg BVAL was bumped one to three basis points: 1.52% (-2) in 2023 and 1.76% (-3) in 2024. The five-year at 2.00% (-3), the 10-year at 2.22% (-3) and the 30-year at 2.54% (-3) at a 4 p.m. read.

Treasury yields fell and equities were down.

The two-year UST was yielding 2.317%, the three-year was at 2.494%, five-year at 2.449%, the seven-year 2.415%, the 10-year yielding 2.325%, and the 30-year Treasury was yielding 2.445% at the close.

Informa: Money market muni assets, yields rise
Tax-exempt municipal money market fund assets added $101.7 million, bringing their up to $85.99 billion for the week ending March 29, according to the Money Fund Report, a publication of Informa Financial Intelligence.

The average seven-day simple yield for the 148 tax-free and municipal money-market funds rose from 0.07% to 0.013%.

Taxable money-fund assets added $33.12 billion, bringing total net assets to $4.442 trillion in the week ended March 29. The average seven-day simple yield for the 774 taxable reporting funds rose from 0.07% to 0.09%.

Inflation still wreaking havoc
Thursday’s economic data gave a glimpse of the impact inflation has had on consumers, analysts said.

“Consumers are only beginning to feel the crimp of inflation, which will continue to get worse before it gets better,” said Grant Thornton Chief Economist Diane Swonk. “The Fed is well aware of that and now ready to chill an overheating economy. Bundle up.”

While the headline number showed spending grew 0.2% in February, after adjusting for inflation, it actually fell 0.4%, she noted. The personal consumption expenditure deflator climbed 0.6% in the month and 6.4% year-over-year. “That is the hottest annual pace for the overall deflator since January 1982,” Swonk said. “It is worth noting that this was before the boost to commodity prices we saw after Russia invaded Ukraine.”

Core PCE grew 0.4% in February and 5.4% year-over-year, the fastest pace since October 1982.

While the personal saving rate crept up to 6.3% in the month, Berenberg Capital Markets Chief Economist for the U.S. Americas and Asia Mickey Levy noted, it “remains significantly below its 2019 average, suggesting households are continuing to draw on savings to meet current spending needs and smooth consumption in the face of accelerating inflation.”

Inflation won’t slow anytime soon, he said. “Measures of headline inflation are likely to rise further in the near term, driven by the steep run-up in food and energy prices through March, and core inflation is likely to remain elevated, reflecting increased demand for services and the lagged impact of rising rent and home price appreciation.”

But some analysts were optimistic.

“February marked the seventh straight month in which inflation outpaced income, raising doubts about consumer spending stamina,” said Wells Fargo Securities Senior Economist Tim Quinlan and Economist Shannon Seery. “Yet, even with inflation at a 40-year high, the 0.4% drop in real spending in February might be overstating the burden and be more of a reflection of an upward revision that made January one of the best months on record for real spending.”

And while inflation will continue to tamp spending, they said, there are “some notable factors helping households.”

First, many consumers remain “in decent financial shape,” Quinlan and Seery said, “and this should not be overlooked.”

Also, rising wages are “beneficial to households even if inflation is currently eating into much of the recent gain,” since. households can use their savings. “We expect households to save less in the near term to offset some of the hit to purchasing power from rising inflation. If they don’t, spending could falter more than we presently forecast.”

Jobs, rather than the Federal Reserve, will be key to cutting inflation, said Bryce Doty, senior vice president/portfolio manager of Sit Investment Associates. “Jobs will do more for easing supply shortages and lessening inflation pressure than anything the Fed can achieve by raising interest rates.”

While rate hikes will lift the cost of purchasing a home or a car, they also push “up companies’ interest expense of which gets passed onto consumers as price increases,” Doty said.

The economy is suffering from a lack of workers to meet the needs of consumers, he said. “So, counter to conventional wisdom, more job creation reduces how high the Fed will need to raise rates before we see a relief in inflation pressures.”

Still, the inversion of parts of the yield curve has some worried.

Padhraic Garvey, ING’s regional head of research, said he’s watching the two year/five year, which has yet to invert. “It likely will,” he said. “But even if it does, history tells us that we could still be years from an actual recession.”

 The curve, flattening and in parts inverting, suggests “Fed hikes will dampen future growth and shove the economy into recession,” said Jason Brady, president and CEO at Thornburg Investment Management.

The Fed’s average inflation targeting lead it to fall behind the curve, he said, “forcing the Fed to raise rates faster and therefore making a hard landing virtually inevitable.”

Recession is a possibility, according to Lindsey Piegza. “With the Fed vowing to raise rates ‘aggressively,’ we estimate the risk of a recession has jumped to well over 50% within the next 21 months,” she said.

But some analysts question the predictive powers of an inversion, Piegza said, “given the perversion of the markets mostly due to unprecedented policy intervention. And there may be some truth to that given the unprecedented levels of quantitative easing the U.S. and other developed central banks have engaged in.”

Still, she now expects slower growth, “with the first negative GDP print potentially as early as Q1 2023.”

The Fed needs to act quickly to regain credibility, said Sebastien Galy, senior macro strategist at Nordea Asset Management. “The Federal Reserve needs to bring the terminal rate or long-term interest rates into positive territory as fast as possible … to avoid an uncontrolled spread of the wage inflation spiral.”

Should the Fed fail, he said, the U.S. will fall into recession. Monetary policy works with a six- to 18-month lag, he said, and “likely longer” with a hot economy. “This is a very long-time for the Fed to decide whether it wants to go ahead of the curve and not run behind inflation.”

And while Galy suggests the Fed “will probably need to turn far more hawkish,” but with midterm elections ahead, that may be difficult.

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