Inflation report sparks large UST selloff, munis outperform for now


Municipals were weaker, but outperformed a large U.S. Treasury selloff that hit the short end the hardest and pushed the 10-year well over 4.5% after a hot inflation report showed Fed rate cuts would be pushed further out. Equities sold off as well.

“The news is sparking an equity market selloff while sending bond yields to the stars as investors dial down their Fed easing expectations again, this time to only two rate cuts this year,” said José Torres, senior economist at Interactive Brokers.

“Furthermore, if future data releases continue to arrive inconsistent with the Fed’s 2% inflation mandate, rate reductions later this year may be complicated by policymakers seeking to avoid the appearance of taking positions on the presidential election campaign, which revs into high gear this summer.”

Muni yields were cut three to seven basis points, while UST yields rose up to 24 basis points, pushing the two-year to nearly 5%. The last time the two-year UST was above 5% and the 10-year was over 4.5% was in mid-November.

The moves pushed muni-to-UST ratios lower. The two-year muni-to-Treasury ratio Wednesday was at 63%, the three-year at 61%, the five-year at 59%, the 10-year at 60% and the 30-year at 83%, according to Refinitiv Municipal Market Data’s 3 p.m. EST read. ICE Data Services had the two-year at 67%, the three-year at 65%, the five-year at 63%, the 10-year at 64% and the 30-year at 86% at 3:30 p.m.

Year-to-date, the “broader interest-rate environment has impacted the muni market, as yields are higher now than since the beginning of the year,” AllianceBerstein strategists noted.

This year, “munis have also been grappling with expensive valuations relative to USTs in certain maturities,” they said.

Munis will eventually move closer to fair value, they said, adding “timing such events is difficult, but nevertheless, this reversion will occur over time.”

The 10-year UST has risen 67 basis points this year, while the 10-year AAA MMD yield is up 44 basis points since the start of 2024.

Outside of Wednesday’s CPI-induced weakness, muni yields have “risen gradually” over the past several weeks, and demand is still strong, said Anders S. Persson, Nuveen’s chief investment officer for global fixed income, and Daniel J. Close, Nuveen’s head of municipals.

The muni bond yield curve is “relatively flat, garnering tremendous interest in both the short and the long ends,” with Persson and Close expecting this trend to continue for a while.

And despite the “lack of compelling relative value,” the attractiveness of absolute yields “invites some investors to continue buying bonds,” said Chris Brigati, senior vice president and director of strategic planning and fixed income research at SWBC.

“The cyclical slowdown typically experienced as we move through the always-critical April 15 tax period provides a reason for the price action and an opportunity to buy,” he said.

The Investment Company Institute reported outflows from municipal bond mutual funds for the week ending April 3, with investors pulling $75 million to funds following $434 million of inflows the week prior.

This outflow cycle marks an end to 12 straight weeks of inflows.

ICI reported exchange-traded funds saw outflows of $19 million following $865 million of inflows the week prior.

In the primary market Wednesday, BofA Securities priced for Kentucky (A1//AA-/) $685.250 million of Kentucky State Property and Buildings Commission of Project No. 130 revenue bonds. Part of the proceeds will be used to refund up to $428.29 million of the state’s outstanding Build America Bonds.

The first tranche, $229.430 million of new-issue bonds, Series 2024A, saw 5s of 11/2025 at 3.50%, 5s of 2029 at 3.04%, 5s of 2034 at 3.13%, 5s of 2039 at 3.60% and 5.25s of 2044 at 3.99%, callable 11/1/2034.

The second tranche, $413.120 million of refunding bonds, Series 2024B, saw 5s of 11/2024 at 3.53%, 5s of 2029 at 3.04% and 5s of 2030 at 3.03%, noncall.

The third tranche, $42.700 million of refunding bonds, Series 2024C, saw 5s of 11/2024 at 3.53%, 5s of 2029 at 3.04% and 5s of 2031 at 3.02%, noncall.

BofA Securities priced for the Dormitory Authority of the State of New York (Aa1/AA//) $600 million of Cornell University revenue refunding bonds, Series 2024A, with 5.5s of 7/2054 at 4.00%, callable 7/1/2034.

BofA Securities priced for the South Dakota Health and Educational Facilities Authority (/AA-/AA-/) $339.410 million of Avera Health revenue bonds, Series 2024A, with 5s of 7/2028 at 3.01%, 5s of 2029 at 2.96%, 5s of 2033 at 3.04%, 5s of 2039 at 3.57%, 4s of 2044 at 4.24%, 4.25s of 2049 at 4.46% and 5.25s of 2054 at 4.26%, callable 7/1/2034.

The primary will be tested tomorrow when California sells $442.635 million of taxable various purpose GOs, $441.495 million of taxable various purpose GOs, and $600 million of tax-exempt various purpose GOs, at noon Thursday.

AAA scales
Refinitiv MMD’s scale was cut three to seven basis points: The one-year was at 3.35% (+5) and 3.12% (+3) in two years. The five-year was at 2.72% (+4), the 10-year at 2.72% (+7) and the 30-year at 3.86% (+5) at 3 p.m.

The ICE AAA yield curve was cut five to six basis points: 3.40% (+5) in 2025 and 3.18% (+6) in 2026. The five-year was at 2.76% (+6), the 10-year was at 2.77% (+6) and the 30-year was at 3.85% (+6) at 3:30 p.m.

The S&P Global Market Intelligence municipal curve was cut five basis points: The one-year was at 3.43% (+5) in 2025 and 3.17% (+5) in 2026. The five-year was at 2.76% (+5), the 10-year was at 2.72% (+5) and the 30-year yield was at 3.85% (+5), according to a 3 p.m. read.

Bloomberg BVAL was cut four to six basis points: 3.37% (+4) in 2025 and 3.16% (+5) in 2026. The five-year at 2.68% (+6), the 10-year at 2.68% (+6) and the 30-year at 3.86% (+5) at 3:30 p.m.

Treasuries sold off.

The two-year UST was yielding 4.968% (+22), the three-year was at 4.798% (+24), the five-year at 4.605% (+23), the 10-year at 4.549% (+19), the 20-year at 4.753% (+16) and the 30-year at 4.630% (+13) at the close.

The consumer price index showed inflation remains above levels the Federal Reserve Bank is comfortable with, and analysts believe the March figures were a death knell for a June rate cut while some now believe the market will have to wait until 2025 for lower rates.

“While we agree with the market’s reaction to substantially reduce the odds of a June cut as well as bringing down the total number of cuts expected in 2024, the massive move we have seen so far (with the 2-year Treasury yield currently trading near 4.95%, up 0.21%) seems like a moderate overreaction to a ‘weak’ 0.4% increase in core inflation especially since the read through to core PCE is probably a little more muted,” said Greg Wilensky, head of U.S. fixed income at Janus Henderson Investors.

A June rate cut, he said, would likely involve “a geopolitical event or shockingly bad labor market data.”

And although the Fed will be disappointed by the data, which “will likely delay the timing for the first rate cut, we do not believe this changes the narrative that the Fed is looking to become less restrictive by lowering policy rates as soon as they feel it is appropriate and is well positioned to act aggressively if the economy falters,” Wilensky said.

“The March CPI inflation report is an unwelcome message to the markets that the Fed’s inflation fight is far from over,” said Scott Anderson, chief U.S. economist and managing director at BMO Economics. “Clearly, restrictive monetary policy has not yet fully done its work.”

Fed Chair Jerome Powell is in no rush to take action, he said, and “must be mulling the possibility that it may need to do more to put a stake in inflation’s beating heart.”

The report suggests “the recent barrage of hawkish Fed speak proved warranted,” said Jeff Schulze, head of economic and market strategy at ClearBridge Investments. ”Achieving the ‘last mile’ of inflation on the journey to the 2% target is going to prove more challenging than initially perceived considering the 3- and 6-month annualized rate of core CPI is running at 4.8% and 4%, respectively.”

CPI “effectively takes June off the table for the first rate cut and should push the odds out further with a coin toss in July or September,” he said. Expect “upward pressure on 10-year Treasury yields along with the broader equity complex as valuations come down.”

This “significant upside surprise … should crush expectations of a June Federal Reserve interest rate cut,” said ING Chief International Economist James Knightley.

And while two employment reports and CPI releases remain before the June meeting, he said, “we would likely need to see payrolls growth drop closer to 100k and both core CPI prints to come in at 0.2% month-over-month” to justify a move.

“Given this situation, a June rate cut is not happening, barring a rapid reversal of fortunes for the economy,” Knightley said. “July is also doubtful, meaning September is the more probable start point of any easing, which would limit the Fed to a maximum of just three rate cuts this year.”

It’s possible there will be no rate cuts this year, according to Giuseppe Sette, president of Toggle AI. “As a rule, the Fed has always kept rates above inflation, short of a recession,” he said. “With both headline and core inflation hovering in a stable orbit around 3.5%, and strong payroll numbers, the hawks in the Fed will have plenty of ammunition to push rate cuts in the future. And quantitative tightening is proceeding smoothly without a hitch in the markets. This is no time for rate cuts.”

The report “makes the Fed’s job more difficult,” said Phillip Neuhart, director of Market and Economic Research at First Citizens Bank Wealth. “The data does not completely remove the possibility of Fed action this year, but it certainly lessens the chances the Fed is cutting the overnight rate in the next couple months.”

Three cuts this year will be “difficult” to accomplish, said David Miller, founder, CIO and senior portfolio manager at Catalyst Funds. “More likely they will be stuck in a higher for longer scenario if they want to maintain their 2% inflation target,” he said. “This will put pressure on longer duration bonds.”

This was the third consecutive core gain of 0.4%, noted Jeffrey Cleveland, director and chief economist at Payden & Rygel. “One month could have been a fluke or a bump in the road, but three months at 0.4% suggests a more durable trend well above the Fed’s target.”

Besides trending “too hot for the Fed to cut,” Cleveland said, “the details don’t provide much comfort either.”

Negotiated calendar:
The Maricopa County Industrial Development Authority (A2//A+/) is set to price Thursday $323.415 million of Honor Health hospital revenue bonds, consisting of $43.030 million of new-issue bonds, Series 2024A, serial 2034; and $280.385 million of forward-delivery refunding bonds, Series 2024D. RBC Capital Markets.

The Marion County School Board, Florida, (/AA//) is set to price Thursday $296.370 million of certificates of participation, Series 2024, serials 2026-2044. BofA Securities.

The Union County Improvement Authority, New Jersey, (Aaa///) is set to price Thursday $102.270 million of Union County Administration Complex Project county-guaranteed lease revenue bonds, Series 2024, serials 2025-2044, terms 2049,2054. RBC Capital Markets.

California is set to sell $442.635 million of taxable various purpose GOs, Bid Group A, at 11 a.m. Thursday; $441.495 million of taxable various purpose GOs, Bid Group B, at 11:30 a.m. Thursday; and $600 million of tax-exempt various purpose GOs, Bid Group C, at noon Thursday.

Broome County, New York, is set to sell $123.458 million of bond anticipation notes at 11 a.m. Thursday.

Gary Siegel contributed to this story.

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