Muni sell-off resumes; debt ceiling, Fed policy uncertainties hang over

Municipals resumed their selloff Tuesday, while U.S. Treasuries were slightly weaker and equities ended down as debt ceiling negotiations and Fed policy uncertainties hang over financial markets.

Triple-A yields rose from two to five basis points on the one-year and up to 10 basis points across the rest of the curve. Municipal to UST ratios rose as a result of the day’s moves.

The two-year muni-Treasury ratio Tuesday was at 73%, the three-year at 75%, the five-year at 74%, the 10-year at 72% and the 30-year at 92%, according to Refinitiv MMD’s 3 p.m. ET read. ICE Data Services had the two-year at 73%, the three-year at 76%, the five-year at 73%, the 10-year at 73% and the 30-year at 93% at 4 p.m.

“It’s good news/bad news for fixed-income markets,” said Nuveen strategists Anders S. Persson and Daniel J. Close.

On the bad news front, they said “mare skittish due to uncertainty surrounding the U.S. debt ceiling, the potential that the Fed could raise rates again in June, and the billions of dollars of bonds being force-liquidated from the portfolios of failed banks.”

In addition, new issuance “has been outsized over the last few weeks,” they noted.

However, Nuveen strategists believe the good news will overcome the bad. 

They said “more than $105 billion of muni reinvestment money is expected over the next three months.”

Additionally, they said inflation is falling, noting “if the Fed continues to raise short-term rates, it would be because inflation is not falling fast enough.”
The debt ceiling is atop of market participants’ minds, even if it’s not driving the market, said Tom Kozlik, managing director at HilltopSecurities.

Whether or not lawmakers can come to an agreement will drive what happens in the markets this summer, he said. If lawmakers come to an agreement — which he believes will happen — he said the “lower primary market issuance environment and not-so-strong demand is going to take over once again,” he said.

Kozlik doesn’t believe demand or issuance will increase substantially in the near term.

Munis have been “getting by” over the past several weeks. From a deal-to-deal perspective, he said there’s just enough demand to get sales done and make it so the market equilibrium isn’t thrown off.

He believes the upcoming weeks will mirror what the last several weeks have been.

This year, he said, is a different environment than 2020 and 2021 where there was “all kinds of money flowing into municipal mutual funds.”

The extreme outflows from 2022 did not happen this year, but smaller outflows persist.

“That has calmed a little bit, but there hasn’t been any type of ongoing strength in demand that is going to cause a lot of consistent buying,” Kozlik said. “And I’m not expecting that dynamic to change anytime soon.”

Mutual fund flows “have slowed to a crawl depriving the primary and secondary markets of price discovery,” said Matt Fabian, a partner at Municipal Market Analytics.

Exchange-traded funds, meanwhile, “are experiencing moderate outflows, perhaps ‘cash alternative’ investors are moving into other asset classes,” he said.

This idea is “supported by a compression in relative value ratios, driven entirely by underperformance up front, those bonds losing some former special richness during the pandemic,” he noted.

Some larger offerings in “last week’s average-sized primary calendar ended up trading to cheaper prices by the end of the week, as did more liquid names trading in the secondary,” according to Fabian.

This uncertain momentum, he said, will likely signal to more conservative/separately managed account investors to “pause buy program — as possible amid the $35 billion of tax-exempt reinvestment needed in June — until X-Date issues have been resolved,” he said.

With issuers “reasonably apt to cut back on issuance plans for the next two weeks at least,” Fabian said “reinvestment will either be short-term constructive or long-term negative, the latter if freed-up dollars don’t find their way back into municipals, possibly permanently.”

Congressional Republicans’ opposition to “any tax increases to help afford current spending, any rate-related upside for tax-exempts also appears highly unlikely,” he said.

Munis are best known for three primary attributes: high income, high credit quality and low volatility, said James Pruskowski, chief investment officer at 16Rock Asset Management.

“In today’s environment of rising ‘rate-vol,’ municipals are bucking the trend,” he said. “Volatility is down, not up, unlike what is being experienced in the U.S. Treasury market.”

Much has “improved for municipals after a dismal 2022 as it relates to supply, demand and valuations,” he said.

While last year “was one of the worst years on record in terms of absolute performance, it offered one of the best years for active management,” he said.

Municipal volatility is “23% lower than its historical peak in 2020 and is currently 4% lower than last year,” according to Pruskowski. He expects this year’s lower volatility trend to continue.

“Today’s environment presents another great opportunity for active management,” he said. “Long-term positives exist for future performance expectations and a potential normalization of the asset classes sleep-well characteristics.”

In the primary market Tuesday, Loop Capital Markets priced for San Antonio, Texas, (Aa2/AA-/AA-/) $647.005 million of electric and gas systems revenue refunding bonds. The first tranche, $461.895 million of New Series 2023A, saw 5s of 2/2024 at 3.56%, 5s of 2028 at 3.10%, 5s of 2033 at 3.16%, 5s of 2038 at 3.72%, 5.25s of 2043 at 4.00%, 5.25s of 2046 at 4.11% and 5.5s of 2050 at 4.19%, callable 8/1/2033.

The second tranche, $185.110 million of New Series 2023B, saw 5s of 2028 at 3.10%, 5s of 2032 at 3.14%, 5s of 2038 at 3.72%, 4s of 2043 at 4.40% and 5.25s of 2044 at 4.04%, callable 8/1/2033.

In the competitive market, Forsyth County, North Carolina, (Aaa/AAA/AAA/) sold $98.500 million of GOs, Series 2023B, to Morgan Stanley, with 5s of 6/2024 at 3.35%, 5s of 2028 at 2.80%, 5s of 2033 at 2.78%, 5s of 2038 at 3.48% and 4.125s of 2043 at 4.15%, callable 6/1/2033.

The county also sold $29.220 million of GOs, Series 2023A, to HilltopSecurities, with 5s of 6/2024 at 3.30%, 5s of 2028 at 2.77%, 5s of 2033 at 2.75%, 5s of 2038 at 3.34% and 4s of 2043 at 4.11%.

Secondary trading
North Carolina 5s of 2024 at 3.32%. Arkansas 5s of 2024 at 3.44%-3.38%. California 5s of 2024 at 3.22%-3.18%.

Washington 5s of 2027 at 2.95%. Indiana Finance Authority 5s of 2028 at 2.95%. Oregon 5s of 2029 at 2.80% versus 2.43% on 5/16.

Florida BOE 5s of 2032 at 2.77%. New Mexico Finance Authority 5s of 2034 at 2.78%. University of California 5s of 2035 at 2.71%-2.70%.

DC 5s of 2045 at 3.77% versus 3.53% on 5/15. Baltimore County, Maryland, 5s of 2047 at 3.75% versus 3.58% original on Friday.

AAA scales
Refinitiv MMD’s scale was cut 10 basis points outside of one-year: The one-year was at 3.31% (+5) and 3.15% (+10) in two years. The five-year was at 2.77% (+10), the 10-year at 2.67% (+10) and the 30-year at 3.62% (+10) at 3 p.m.

The ICE AAA yield curve was cut two to 10 basis points: 3.37% (+2) in 2024 and 3.18% (+7) in 2025. The five-year was at 2.80% (+10), the 10-year was at 2.71% (+10) and the 30-year was at 3.70% (+8) at 4 p.m.

The IHS Markit municipal curve was cut 10 basis points outside of one-year: 3.30% (+5) in 2024 and 3.15% (+10) in 2025. The five-year was at 2.77% (+10), the 10-year was at 2.66% (+10) and the 30-year yield was at 3.62% (+10), according to a 4 p.m. read.

Bloomberg BVAL was cut four to eight basis points: 3.14% (+4) in 2024 and 3.03% (+5) in 2025. The five-year at 2.70% (+7), the 10-year at 2.62% (+7) and the 30-year at 3.64% (+6) at 4 p.m.

Treasuries were little changed more than a basis point or two.

The two-year UST was yielding 4.344% (+2), the three-year was at 4.000% (+1), the five-year at 3.761% (-1), the 10-year at 3.704% (-2), the 20-year at 4.091% (-1) and the 30-year Treasury was yielding 3.952% (-2) at 4 p.m.

Primary to come:
The New Jersey Transportation Trust Fund Authority (A2/A-/A/A/) will price $674 million of Series AA transportation program bonds on Thursday. Jefferies.

The authority (A2/A-/A/) is also set to price $262.780 million of Series A transportation system bonds on Thursday. Jefferies.

The Metropolitan Washington Airports Authority (Aa3/AA-/AA-/) is set to price $433.115 million of Series 2023 A airport system revenue and refunding bonds subject to the AMT on Wednesday. Barclays Capital.

The Pennsylvania Housing Finance Agency (Aa1/AA+//) is set to price $387.270 million of Series 2023 -142A, non-AMT single-family mortgage revenue social bonds on Wednesday. Serials 2028 to 2034; terms in 2038, 2041, 2043, 2046, 2048, 2050, 2053. Jefferies.

The Oregon Department of Transportation (Aa2/AA+/AA+/) is set to price $210.640 million of Series 2023 A highway user tax revenue subordinate lien bonds on Wednesday. Serials 2035 to 2042. Wells Fargo Bank.

Georgetown, Texas, (/AA//) is set to price $101.400 million of Series 2023 utility system revenue bonds insured by Build America Mutual Assurance Co. on Wednesday. Serials 2024 to 2043; terms 2048, 2053. Bok Financial Securities.

San Antonio, Texas, (Aa3/A-plus/AA-minus/) is set to price $100.300 million of electric and gas systems variable rate junior-lien Series 2023 revenue refunding bonds on Wednesday. Term in 2053. Barclays Capital.

Brazoria County, Texas, Industrial Development Corp. is set to price $100 million of solid waste disposal facilities revenue bonds for the Aleon Renewable Metals LLC Project on Wednesday. Truist Securities.