After lagging UST for weeks, munis see minor correction

Municipal triple-A benchmark yields rose as much as eight basis points on the short end on certain scales Thursday as U.S. Treasury yields remained elevated and equities see-sawed as more hawkish Fed speak continued.

The Federal Reserve expects Omicron to fizzle in weeks, and while pandemic-related risks remain, the economy is strong and the Fed needs to address inflation and could liftoff as soon as March, Federal Reserve Bank of St. Louis President James Bullard said Thursday.

“The FOMC could begin increasing the policy rate as early as the March meeting in order to be in a better position to control inflation,” he said. “Subsequent rate increases during 2022 could be pulled forward or pushed back depending on inflation developments.”

While rate increases have been expected, the calendar flip to 2022 has intensified market reactions to the potential sooner-than-anticipated hikes.

Those pressures finally caught up to munis after weeks of static yields. Refinitiv MMD cut its scale five basis points top to bottom, while ICE Data Services saw larger cuts of up to eight basis points on the short end of its scale to three to four basis point cuts out longer. Bloomberg BVAL saw four to six basis point cuts across its curve and IHS Markit cut levels by three to five basis points.

Refinitiv MMD’s Senior Market Analyst Peter Franks noted the last two times MMD moved its scales in either direction by five basis points was on Nov. 9 when it bumped its 10-year five and prior to that it was a five basis point cut on Oct 21. From Nov. 30 until Dec. 31, the 10-year sat at 1.03%. MMD’s 10-year on Thursday is at 1.12%.

Municipal to UST ratios rose slightly on Thursday. The five-year was at 46%, 65% in 10 and 75% in 30, according to Refinitiv MMD’s 3 p.m. read. ICE Data Services had the five at 43%, the 10 at 64% and the 30 at 72%.

“Fundamentals outside of municipals are more volatile now and ongoing rich valuations put generic yields more on the defensive than is customary so early in the month,” said Kim Olsan, senior vice president at FHN Financial. “Bids wanted volume is running higher for a month that should have more demand. In the first three days of the month, the daily average is above $600 million and about 10% higher than 2021’s rate.”

Olsan noted the bulk of block items on Wednesday fell below the $5 million mark “as sellers are perhaps aware of elevated dealer carry ($13 billion last reported figure) and are avoiding advertising larger positions.”

Secondary trading pointed to a concentration of volume in 4s-5s past five years as rate risk comes into the forefront, she said.

Secondary trading showed various prints at much weaker levels, evident in the cuts to scales.

New York Dorm PIT 5s of 2023 at 0.40% in a late trade. Georgia 5s of 2025 at 0.60% versus 0.54% Wednesday. California 5s of 2026 at 0.72%. Maryland 5s of 2026 at 0.68%-0.67%. Ohio common school 5s of 2026 at 0.66%-0.64%.

Loudoun County, Virginia, Sanitation District 5s of 2028 at 0.83%. Massachusetts 5s of 2028 at 1.01%. Georgia 5s of 2028 at 0.89%. Minnesota 5s of 2029 at 1.01%. California 5s of 2030 at 1.13%. New York City 5s of 2030 at 1.18%.

In the primary Thursday, Ramirez & Co., Inc. priced for the Los Angeles Airports Department (Aa3/AA-/AA-/) $503.22 million consisting of $346.215 million of private activity AMT subordinate revenue bonds 2022 Series A and $157.005 million of non-AMT subordinate revenue bonds 2022 Series B. The AMT portion saw 5s of 5/2026 yield 0.80%, 5s of 2032 at 1.58%, 4s of 2037 at 1.96%, 4s of 2042 at 2.11% and 4s of 2049 at 2.27%, callable 5/15/2032. The non-AMT portion saw 5s of 5/2026 at 0.57%, 5s of 2027 at 0.72%, 5s of 2032 at 1.23%, 5s of 2037 at 1.53%, 5s of 2042 at 1.68% and 4s of 2048 at 2.04%, callable 5/15/2032.

The Bond Buyer 30-day visible supply grew to $9.06 billion Thursday. As supply rolls in, a more constructive flow should emerge for munis.

Funds still engaged to start 2022
In the week ended Jan. 4, weekly reporting tax-exempt mutual funds saw $840.848 million of inflows, Refinitiv Lipper said Thursday. It followed an inflow of $1.202 billion in the previous week.

Exchange-traded muni funds reported inflows of $246.341 million, after inflows of $474.034 million in the previous week. Ex-ETFs, muni funds saw inflows of $594.508 million after inflows of $727.921 million in the prior week.

The four-week moving average increased to $980.815 million from $971.511 million in the previous week.

Long-term muni bond funds had inflows of $717.697 million in the latest week after inflows of $1.009 billion in the previous week. Intermediate-term funds had inflows of $224.168 million after inflows of $179.553 million in the prior week.

National funds had inflows of $826.058 million after inflows of $1.226 billion while high-yield muni funds reported inflows of $398.025 million in the latest week, after inflows of $424.034 million the previous week.

AAA scales
Refinitiv MMD’s scale was cut five basis points across the curve at the 3 p.m. read: the one-year at 0.25% and 0.35% in 2023. The 10-year at 1.12% and the 30-year at 1.58%.

The ICE municipal yield curve showed yields rise as much as eight basis points: to 0.26% (+8) in 2022 and 0.33% (+8) in 2023. The 10-year at 1.13% (+5) and the 30-year yield at 1.55% (+3) at the 4 p.m. read.

The IHS Markit municipal analytics curve was cut by three to five basis points: 0.22% (+3) in 2023 and 0.33% (+5) in 2024. The 10-year at 1.09% (+5) and the 30-year at 1.57% (+5) as of a 4 p.m. read.

Bloomberg BVAL was saw three to four basis point cuts to scales: 0.22% (+2) in 2022 and 0.29% (+2) in 2023. The 10-year at 1.11% (+3) and the 30-year at 1.57% (+4) at 4 p.m. read.

Treasuries saw continued losses while equities were mixed.

The five-year UST was yielding 1.47%, the 10-year yielding 1.724%, the 20-year at 2.111% and the 30-year Treasury was yielding 2.08% at the close. The Dow Jones Industrial Average was down 170 points, or 0.47%, the S&P was up 0.32% while the Nasdaq lost 0.13% at the close.

More aggressive rate hike path
St. Louis Fed President Bullard on Thursday also advocated “additional steps as necessary to control inflation, including allowing passive balance sheet runoff, increasing the policy rate, and adjusting the timing and pace of subsequent policy rate increases.”

The Federal Open Market Committee meeting minutes suggested officials can envision a more aggressive rate hiking path.

But the labor market is the other highlight of the week.

Wednesday’s “unambiguously strong” ADP report and the initial jobless claims report suggest “the labor market ended 2021 on a strong note, and there remains very strong demand for workers,” said Scott Ruesterholz, a portfolio manager at Insight Investment.

Despite the ADP data “largely reflect[ing] activity prior to Omicron,” he said, “the labor market has recovered markedly and is on track to return to the pre-COVID 3.5% unemployment rate this year, which will enable the Fed to commence a rate hiking cycle by midyear.”

While Omicron could hit the January numbers, Ruesterholz said, any impact from the variant should be “short-lived.”

Others agree. “The year ahead promises to be another one of extremely tight labor markets (especially in the U.S.), where we expect wages to continue their sharp climb as businesses bid for workers,” said James Solloway, chief market strategist at SEI’s Investment Management Unit.

The biggest challenge for the Federal Reserve going forward, he said, will be finding “the proper balance between having an economy run above its long-term potential in the interests of achieving full and inclusive employment versus the need to lean against inflation pressures that are starting to look more entrenched.”

Initial jobless claims grew to 207,000 in the week ended Jan. 1 from an upwardly revised 200,000 the week before, while continuing claims climbed to 1.754 million in the week ended Dec. 25 from 1.718 million a week earlier.

Despite the uptick, claims are near the lowest levels in decades, said Mark Hamrick, senior economic analyst at Bankrate. “This suggests workers can be reasonably confident about job security and an upbeat employment outlook for this year.”

The biggest labor market issues, he said, are whether employers will be able to find workers and how many people will return to the workforce.

The Institute for Supply Management’s December services survey suggested slower growth in the economy, with prices climbing higher.

The services PMI dropped to 62.0 in December from 69.1 in November, while the business activity/production index declined to 67.6 from 74.6.

Economists polled by IFR Markets expected the PMI to fall to 66.8.

The prices index rose to 82.5 from 82.3, “just spitting-distance from an all-time high,” said Wells Fargo Securities Senior Economist Tim Quinlan and Economist Shannon Seery. “New orders and activity softened as the Omicron surge began to bite into service sector activity.”

Omicron was also cited by Berenberg Capital Markets Chief Economist for the U.S. Americas and Asia Mickey Levy. “The Omicron variant-driven surge in COVID-19 cases is likely to further curtail services sector business activity in the near term as consumers adjust their consumption patterns in response,” he said.

Also released Thursday, the international trade deficit rose to a near-record $80.2 billion in November from $67.2 billion in November, “practically reversing the sharp narrowing in the deficit a month earlier,” Quinlan and Seery said. “Strong imports continue to reflect the more robust recovery in the United States but are also a sign of incremental improvement in easing supply chain constraints.”

Economists had expected a $70.0 billion shortfall.

Separately, factory orders jumped 1.6% in November after a 1.2% rise in October, while excluding transportation orders gained 0.8% after a 1.5% increase.

Economists expected orders to grow 1.3%.

It will be difficult to duplicate 2021’s success in 2022, and all signals point to a considerably tougher year ahead for munis due to slightly higher rates and richer ratios, according to Barclays PLC.