Munis mixed; ICI reports highest outflows since March 2020

Bonds

Municipals were mixed as U.S. Treasury yields fell for the second straight session, while the Investment Company Institute reported $4.8 billion of outflows, the highest since March 2020.

Triple-A muni yields rose up to four basis points, depending on the scale, while UST yields fell two to six on bonds 10 years and in. Muni-UST ratios were at 84% in five years, 92% in 10 years and 101% in 30, according to Refinitiv MMD’s 3 p.m. read. ICE Data Services had the five at 83%, the 10 at 92% and the 30 at 100% at 4 p.m.

In the week ending April 6, investors pulled more from municipal bond mutual funds as the Investment Company Institute on Wednesday reported $4.786 billion of outflows, up from $4.459 billion of outflows in the previous week.

Exchange-traded funds saw inflows at $151 million versus $750 million of inflows the week prior.

The last of the week’s largest deals priced in the primary. Wells Fargo Bank priced for Anaheim Housing and Public Improvements Authority, California (/AA-/AA-/) $264.9 million of bonds. The first tranche, $156.52 million of Electric Utility Distribution System Improvements revenue bonds, Series 2022-A, saw bonds in 10/2023 with a 5% coupon yield 2.04%, 5s of 2027 at 2.46%, 5s of 2032 at 2.74%, 5s of 2037 at 2.93%, 5s of 2041 at 3.01%, 5s of 2047 at 3.17% and 5s of 2052 at 3.25%, callable 10/1/2027.

The second tranche, $74.280 billion of Electric Utility Distribution System Improvements revenue bonds, Series 2022-B, saw bonds in 10/2024 with a 5% coupon yield 2.26%, 5s of 2027 at 2.46%, 5s of 2032 at 2.74% and 5s of 2034 at 2.84%, callable 10/1/2027.

The third tranche, $34.095 billion of Electric Utility Distribution System Refunding revenue refunding bonds, Series 2022-E, saw bonds in 10/2028 with a 5% coupon yield 2.65% and 5s of 2030 at 2.79%, callable 10/1/2027.

In the competitive market, California Public Works Board (Aa3/A+/AA-/) sold $293.345 million of green/climate-certified California Air Resources Board lease revenue bonds, 2022 Series D. Bonds in 5/2023 with a 5% coupon yield 1.89%, 5s of 2027 at 2.50%, 5s of 2032 at 2.86%, 4s of 2037 at 3.41%, 4s of 2042 at 3.52% and 4s of 2047 at 3.60%, callable 5/1/2032.

The new higher-yield environment is a buying opportunity and investors should jump in now, according to BlackRock’s Peter Hayes, James Schwartz, and Sean Carney.

Difficult supply-and-demand dynamics have resulted in significant municipal underperformance since the beginning of the year, but “after a quarter of severe correction, we believe that higher absolute yields and attractive relative valuations provide a favorable entry point,” they said.

“While bouts of volatility could persist in the near-term, we think investors will ultimately benefit from entering early and taking advantage of the current muni availability ahead of the typically strong summer season.”

While higher-rated bonds and those with a shorter duration outperformed because they are less sensitive to interest rate changes, the market was strained in March by weak demand, increased secondary selling and more robust supply.

They said fundamentals in the municipal market are being bolstered by the strong U.S. economy. Several high-profile municipal credits have been upgraded due to strong revenue growth, improved financial management and increased fund balances.

“But despite strong fundamentals, rising rates and weak supply and demand dynamics have caused cheapening across the municipal market,” BlackRock strategists. “Investors should view this as an opportunity to source high-quality tax-exempt assets at better levels than the start of the year.”

Bids-wanted activity has been a large part of the secondary market story so far in 2022 with Tuesday’s total eclipsing $2 billion, the highest in more than two years and the 36th day above $1 billion. Bids-wanteds were elevated again Wednesday, but not as high as the market heads toward the holiday weekend.

Bid lists have remained elevated and provided added price transparency as investors raised cash to meet redemptions, noted Kim Olsan, senior vice president of municipal bond trading at FHN Financial.

But despite a bid list windfall, Tuesday saw a slight improvement in buy/sell momentum, Olsan said. Bloomberg’s tally of bids wanted in competition is causing the market to be held back once more. Municipal Securities Rulemaking Board data showed customer buying was more active after 2030, but less so at the shorter end of the curve, she said.

Among the outsized bid lists on any given day, she said several sellers of short calls and maturity dates are outpacing interested buyers, which is one of the causes for a larger decline inside 2027 maturity dates this year.

Olsan said the yield correction this year has brought the performance of municipal bonds in comparison to other asset classes into more focus.

For comparisons, Olsan looked at performance since 2020. She said tax-exempt municipals had the second-lowest return among the UST, corporate and mortgage-backed security sectors in 2020, save for beating mortgage-backed security by more than 100 basis points. A recovery in the second half of the year allowed a main muni index to recoup earlier losses during the COVID-led selloff.

Taxable munis surged in demand at the time issuance exploded to nearly $150 billion on strong refunding volume, she noted. The sector gained more than 11% in 2020 and Refinitiv MMD data showed the year ended with 20-year AA taxable munis yielding 2.59% against AA corporates trading at 2.39%.

Looking at 2021, tax-exempt munis gained 1.52%, about the same figure USTs lost over the year.

“A favorable bidside led by consistent fund inflows and strong credit quality led to the outperformance,” Olsan said. “Taxable munis posted a similar gain to tax-exempts with steady cross-market buying, outperforming UST, corporate and MBS indices.”

Now looking at this year, tax-exempt munis returns are poor by historical standards but not the worst of the group.

Olsan noted that a 7.32% loss is about 100 basis points outperformance to the U.S. Aggregate index.

Taxable munis “have succumbed to additional pressures against other taxable sectors, down over 11%,” she said.

A decline in issuance this year corresponds with a smaller share of the overall total, just 21% through Q1 vs. 44% in 2020 and 34% in 2021.

“One aspect to the extreme rate backup in tax-exempts is the real yield opportunity for more traditional taxable-sector buyers,” she said.

A greater variety in couponing past 20 years adds to the allure, she said, pointing to low-AA and single-A state-level credit 4% structures that are now trading at discounts, which is an adjustment of more than 150 basis points.

Secondary trading
Washington 5s of 2024 at 2.10% versus 2.16% Monday. District of Columbia 5s of 2025 at 2.20%. New Mexico 5s of 2025 at 2.23%. California 5s of 2025 at 2.23%-2.18%. Georgia 5s of 2025 at 2.20%-2.17%.

Mecklenburg County, North Carolina 5s of 2026 at 2.20%-2.21%. Baltimore County, Maryland 5s of 2026 at 2.24%-2.20%. Maryland 5s of 2026 at 2.31%-2.28%.

Prince Georges County, Maryland 5s of 2029 at 2.43%-2.42%. California 5s of 2029 at 2.56% versus 2.38% on 4/7. Florida Board of Education PECOs 5s of 2030 at 2.45%-2.47%. University of Texas 5s of 2032 at 2.55% versus 2.40% original.

Washington 5s of 2037 at 2.87% versus 2.87%-2.86% original.

MTA 5s of 2047 at 3.37% versus 3.37% original. LA DWP 5s of 2051 at 3.16% versus 3.10% yesterday.

AAA scales
Refinitiv MMD’s scale was cut two to four basis points at 3 p.m. read: the one-year at 1.77% (unch) and 2.03% in two years (unch). The five-year at 2.22% (+2), the 10-year at 2.46% (+4) and the 30-year at 2.81% (+4).

The ICE municipal yield curve was little changed: 1.76% in 2023 and 2.06% in 2024. The five-year at 2.22%, the 10-year was at 2.47% and the 30-year yield was at 2.84% at the close.

The IHS Markit municipal curve was cut up to three basis points: 1.78% (unch) in 2023 and 2.03% (+3) in 2024. The five-year at 2.25% (+3), the 10-year at 2.44% (+3) and the 30-year at 2.82% (+3) at a 4 p.m. read.

Bloomberg BVAL was cut a basis point in spots: 1.75% (+1) in 2023 and 1.99% (unch) in 2024. The five-year at 2.23% (unch), the 10-year at 2.45% (unch) and the 30-year at 2.78% (+1) at a 4 p.m. read.

Treasury yields fell but ended flat on the 20- and 30-year.

The two-year UST was yielding 2.359% (-5), the three-year was at 2.574% (-6), five-year at 2.657% (-3), the seven-year 2.713% (-4), the 10-year yielding 2.702% (-2), the 20-year at 2.989% (flat) and the 30-year Treasury was yielding 2.811% (flat) at the close.

Informa: Money market muni assets rise
Tax-exempt municipal money market fund assets added $2.01 million, bringing it up to $91.20 billion for the week ending April 12, 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 dropped from 0.014% to 0.012%.

Taxable money-fund assets lost $11.90 billion, bringing total net assets to $4.412 trillion in the week ended April 12. The average seven-day simple yield for the 774 taxable reporting funds rose from 0.10% to 0.11%.

Inflation not going away
The producer price index, which came in above expectations, suggests price pressures will continue.

“Various dissections of yesterday’s CPI report pointed to some signs of cooling price pressures, but this morning’s PPI data suggest producers are dealing with broad-based price increases and lingering supply chain issues,” said Will Compernolle, senior economist at FHN Financial.

March producer prices came in higher than expected, he said, “underscoring momentum for a 50 bp hike at the May FOMC meeting.” The headline number’s 1.4% rise shows pressures “are not limited to impacts from the Russian invasion,” Compernolle said.

PPI will have to show “supply is realigning closer with demand” before consumer prices can demonstrate “meaningful disinflationary momentum,” he said.

And while the gains were “driven by sizable increases in food and energy prices,” Berenberg Capital Markets Chief Economist for the U.S. Americas and Asia Mickey Levy said, “continued disruptions to energy and agricultural commodity flows out of Russia and Ukraine paired with a jump in fertilizer costs could accentuate these price pressures, which are likely not yet fully reflected in producer prices.”

The pressures were broad based, Levy noted, with many goods and services seeing “significant” price increases in March. “Producer price pressures do not appear to be easing and will likely be exacerbated by COVID-19 associated lockdowns and factory closures in China,” he added.

While strong demand has allowed businesses to pass on increased costs, Levy said accelerating inflation, which in recent months has been driven by soaring food and energy prices, “has eroded consumer purchasing power and could crimp business pricing power.”

Despite the CPI report Tuesday, which many took as showing inflation was near or at its peak, Scott Ruesterholz, a portfolio manager at Insight Investment, said rents hold the key to inflation.

With rents being “sticky,” he expects CPI will be steady but above target for at least two years.

“With U.S. inflation at the highest levels since the 1980s, investors are worried about how long inflation will remain elevated,” Ruesterholz said. “We attempted to answer this question — not by looking at supply chains, energy prices or goods and services — but by focusing on what has historically been the most persistent and long-term driver of CPI: rental inflation.”

And there’s not much the Federal Reserve can do. “The Fed potentially has limited ability to return CPI to its target in the medium term.”

Still, “inflation is a notoriously difficult macro-economic variable to forecast,” said Jake Remley, senior portfolio manager at Income Research + Management. “Historically, a real wage-price spiral takes years to germinate in the economy. Shorter spikes have happened after wars and other global disruptions.”

If consumers hold back on spending, he warned, “stagflation can set in.”

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