Municipals called it a summer Friday with the secondary lightly traded and benchmarks little changed, even as U.S. Treasury yields rose, munis took a break from the relative volatility since the FOMC meeting midmonth.
After a week and change of underperformance to U.S. Treasuries, where ratios moved higher for the first time since early in the second quarter and rates rose by 10 to 12 basis points, municipals outperformed Friday with some prints even showing firmness in the secondary.
Some participants question why such earlier movements occurred when fundamentals haven’t shifted. Fund flows are massive, particularly high-yield, credit quality is objectively improving due to a faster COVID recovery boosted by federal aid, and investors are flush with cash needing to be put to work.
Perhaps Friday’s session was a moment to consider the answers.
“Municipal investors are still quite puzzled by the recent price action, with long-dated munis again underperforming Treasuries this week despite the massive inflows that seemed to have picked up their pace in the past several weeks as well as heavy summer redemptions,” said Barclays strategists Mikhail Foux, Clare Pickering and Mayur Patel.
In Barclays’ view, tax-exempts have been underperforming because of a combination of factors.
They noted that because tax-exempts have been quite rich, their valuations were driven tighter due to supportive technicals and robust demand, as well as expectations for higher taxes.
“Maybe valuations are a bit cheaper after the correction, but still rich compared with historic levels,” they wrote.
On Friday, municipal-to-UST ratios were slightly lower from earlier in the week at 68% in 10 years while the 30-year was at 73%, according to Refinitiv MMD. ICE Data Services had the 10-year muni-to-Treasury ratio at 64% and the 30-year at 69%.
Refinitiv MMD had the five-year at 55% and ICE pegged it at 51%.
Tax-exempt supply is not overwhelming, but it has been steadily picking up as of late and rate volatility is “never good for the market, especially for long-dated bonds.”
Secondary liquidity is poor, as usually happens during the summer vacation months, they and others noted.
“Hence, not much selling is needed to push yields higher,” they said.
“Finally, as we discussed last week, investors are probably less certain that both individual and corporate taxes are going up after the bipartisan agreement on infrastructure was announced on Thursday by President Biden,” they said.
“While we can understand the negative effects of all factors … the net result is still a bit surprising,” according to Barclays. “We think technicals remain strong, and if anybody was willing to buy bonds in the past several months, this correction presents an opportunity to add to their holdings. In our view, muni ratios will likely move sideways in the next several months, but we would not be surprised if they actually decline if more investors find current valuations appetizing.”
The total potential volume for next week is estimated at $7.27 billion, down from total sales of $7.818 billion this week. There are $4.969 billion of negotiated deals scheduled versus a revised $5.84 billion that were sold this week. Bonds scheduled for competitive sale next week total $2.3 billion compared with $1.978 billion this week.
The largest deal of the week comes from the New York City Municipal Water Finance Authority with $450 million of tax-exempt fixed-rate bonds. The bonds will be offered to retail on Tuesday and be priced for institutions on Wednesday, led by book-running lead manager UBS Financial Services Inc. The largest competitive deals come from Portland Public School District #1J, Oregon, with a $401.9 million taxable offering Thursday and the Santa Clara, California, Finance Authority with $337.7 million on Tuesday.
The credits, from utilities to water and sewers to school districts, provide investors with a diverse mixture of debt to go through for month- and quarter-end.
Reinvestment needs, infrastructure debates add to the conversation
Reinvestment demand will continue to be the focus over the next several weeks — and likely through the summer, according to JB Golden, portfolio manager at Advisors Asset Management.
“Flows continue to reflect high demand, valuations remain supported by a host of tailwinds and, from our seat, investor appetite for the municipal asset continues to be robust,” Golden said. The recent higher rates and ratios, he said, created “a nice entry point for new monies and swaps.”
“With that said, for all the recent taper talk the fundamentals that propelled the market to positive returns through the first half of the year remain in-tact,” he said.
While the backdrop for the market remains bright and fundamentals remain strong, Golden said the tone seems to be more of “wait and see,” which probably reflects the broader economic environment.
“Political tailwinds seem to be priced in and without further developments on that front likely won’t play much of a role,” Golden said.
“Interest rates remain anchored on the quarter — albeit with some recent volatility — but it still looks as if markets are still questioning labor market trajectory and the transitory/not-transitory inflation debate rages on,” he added.
Credit spreads across most of the investment-grade universe seem to have been fully priced into the pandemic recovery — although supply constraints in the face of heavy June reinvestment demand could be a catalyst for price appreciation in the near term, he noted.
“Unless we see significant progress on infrastructure and/or get further confirmation as it relates to labor markets and inflation, coupons will likely be left to do the heavy lifting and will likely remain the larger driver of municipal returns as the summer season plays out,” Golden added.
Secondary trading and scales
Secondary prints showed some firmness and recently issued paper actually traded up in some cases.
Anne Arundel County, Maryland, 5s of 2022 traded at 0.13% versus 0.15% Thursday. Montgomery County, Maryland, 5s of 2023 at 0.21%. California 5s of 2024 at 0.22% versus 0.24% Wednesday. Washington 5s of 2025 at 0.38%. Collin County, Texas, 5s of 2025 at 0.38% versus 0.39% Thursday. (The issuer will price a $100 million refunding next week.)
Prince George’s County, Maryland, 5s of 2027 traded at 0.65%-0.64%. Massachusetts 5s of 2027 at 0.69%. California 5s of 2028 at 0.78%.
Georgia 3s of 2041 traded at 1.70%, same as Thursday. Hennepin County, Minnesota, 5s of 2034 at 1.25%-1.24%.
Longer out, Lone Star College 4s of 2046 at 1.74%-1.73% versus 1.77% original.
High-grade municipals were little changed on all triple-A benchmarks on Friday. According to Refinitiv MMD’s AAA, short yields were steady at 0.12% and at 0.16% in 2021 and 2022. The yield on the 10-year stayed at 1.01% while the yield on the 30-year sat at 1.52%.
The ICE AAA municipal yield curve showed bonds steady in 2022 at 0.11% and 0.16% in 2023. The 10-year maturity was at 1.00% and the 30-year yield sat at 1.51%.
The IHS Markit municipal analytics AAA curve showed short yields steady at 0.13% and 0.16% in 2021 and 2022, respectively, with the 10-year unchanged at 1.01%, and the 30-year yield rose one to 1.52%.
Bloomberg BVAL AAA curve showed short yields steady at 0.12% and 0.15% in 2021 and 2022, with the 10-year up one basis point to 1.01% and the 30-year yield up one to 1.54%.
In late trading, the 10-year Treasury was yielding 1.53% (+4) and the 30-year Treasury was yielding 2.16% (+6). Equities were up, with the Dow Jones gaining 267 points, or 0.79%, the S&P 500 up 0.38% while the Nasdaq gained 0.04%.
Kashkari: Employment needs to bounce back
If employment doesn’t rebound significantly, inflation will be a concern, according to Federal Reserve Bank of Minneapolis President Neel Kashkari.
“Maximum employment means at a minimum, getting those up to 10 million people who were employed pre-pandemic, who are currently unemployed, back into the workforce,” Kashkari said. “If those people don’t return to the workforce, I would then be concerned about inflation.”
The Phillips curve suggests inflation and employment are inversely “linked together, like a see-saw,” he noted. Economists have questions whether the Phillips curve is still a valid measure since prior to the pandemic low unemployment didn’t increase inflation.
But, he added, he expects them to return to the workforce, although it won’t be until after the summer when federal financial incentives run out.
“If I were one of the people choosing not to work right now, I might sit back, enjoy the summer months, continuing getting paid to not work,” he said during a fireside chat hosted by the Minneapolis Fed on Friday morning. “We will see what happens when school starts back up in September.”
Economic data released Friday, suggests “notable” inflation, although it is likely to be temporary, as the Federal Reserve expects.
“The inflation [we are seeing] is generally in line with consumer expectations, and, as a result, it isn’t having a particularly negative impact on the economy itself or people’s perceptions of it,” said Tendayi Kapfidze, LendingTree chief economist. “The economic recovery should continue.”
Personal income fell 2.0% in May after sinking an unrevised 13.1% in April, while spending dipped 0.4% in May after climbing a downwardly revised 0.3% in April, first reported as a 0.5% increase.
The PCE price index rose 0.4% in May after 0.6% gain in April. The core PCE rose 0.5% after a 0.7% rise in April. Compared to a year ago, the PCE price index jumped 3.9%, compared to a 3.6% rise year-over-year in April, and the core gained 3.4%, after a 3.1% annual gain a month earlier.
Economists polled by IFR Markets expected a 2.5% drop in income, a 0.3% increase in consumption, a 0.6% climb in core PCE for the month and 3.4% growth in core PCE on an annual basis.
“Consumers are shifting their focus from spending on goods to services, but the underlying trend for consumer spending remains red-hot,” said Diane Swonk, chief economist at Grant Thornton. “The result is showing up in prices. Many of the increases we are currently seeing will play out as we move into the summer months when the effect of a sharp drop in prices a year ago dissipates. The remainder will intensify debate within the Fed about when to taper asset purchases and hike rates.”
With stimulus checks long-since cashed, “transfer payments fell, but every other category of income rose, which suggests that if income trends continue in the absence of a sharp drop in transfers, income growth is on track to be able to sustain spending this year,” said Wells Fargo Securities Senior Economist Tim Quinlan and Economist Shannon Seery.
Also released Friday, the University of Michigan consumer sentiment index grew to 85.5 in the final June read from 82.9 in May. The preliminary June read was 86.4.
Economists expected a reading of 86.5.
The current conditions index fell to 88.6 in June from 90.6 in mid-month and 89.4 in May, while the expectations index climbed to 83.5 from 78.8 in May, but off from 83.8 in the preliminary read.
“Not only did year-ahead inflation expectations fall slightly to 4.2% in June from May’s decade peak of 4.6%, consumers also believed that the price surges will mostly be temporary,” said Richard Curtin, chief economist, Surveys of Consumers.
LendingTree’s Kapfidze said the drop in inflation expectations “further cements” the notion that “relatively high” inflation hasn’t dampened views of the economy its path. “Longer-term inflation expectations also fell to 2.8% from 3.0%, suggesting that people have become more used to inflation than they were in May and now view it more as a symptom of a recovering economy than as a major cause for concern.”
Tennessee’s GO deal nets 1.41% TIC
Tennessee sold $658.7 million of general obligation bonds this week, the biggest GO deal in the state’s history.
The deal netted a true interest cost of 1.41%.
The gilt-edged bonds were rated triple-A by Moody’s Investors Service, S&P Global Ratings and Fitch Ratings. All three agencies assigned stable outlooks to the credit.
Jefferies priced the $490.9 million of Series 2021B taxable GOs. The bonds were priced at par to yield from 0.116% in 2021 to 1.975% in 2035.
Co-managers were FHN Financial Capital Markets, Truist, UBS Financial Services and Wells Fargo Securities.
Proceeds of the taxables will be used to currently and advance refund some of the state’s outstanding GOs for net present value savings.
FHN Financial Capital Markets priced the $167.755 million of Series 2021A tax-exempt GOs to yield from 0.12% with a 5% coupon in 2022 to 1.47% with a 4% coupon in 2041.
Co-managers for the Series 2021A bonds were Loop Capital Markets, Morgan Stanley, PNC Capital Markets, Raymond James & Associates, and Wells Fargo Securities.
The tax-exempts were composed of new money and current refunding bonds. Proceeds will be used to finance capital projects, retire commercial paper notes and to currently refund some GOs for net present value savings.
PFM was the financial advisor and Hawkins Delafield & Wood was the bond counsel.
Primary market to come
The New York City Municipal Water Finance Authority (Aa1/AA+/AA+/) is set to price $450 million of water and sewer system second general resolution revenue bonds for retail on Tuesday and for institutions Wednesday consisting of fiscal 2022 Series AA-1, $400 million serials 2048 and terms 2051, and $50 million of Series AA-2, serials 2028. UBS Financial Services Inc. will run the books.
The Harris County Cultural Education Facilities Finance Corp. (Aa2/AA/AA/) is set to price on Wednesday $320 million of Texas Children’s Hospital revenue bonds, $245 million Series 2021A and $75 million Series 2021B. Goldman Sachs & Co. LLC is lead underwriter.
The City of Philadelphia (A2//A/) is set to price $298.28 million of AMT PAB airport revenue and refunding bonds on Tuesday. BofA Securities is head underwriter.
The State of New York Mortgage Agency (Aa1///) is set to price for retail on Tuesday and institutions on Wednesday $262.7 million of homeowner mortgage revenue social bonds, $149.7 million of Series 233, serials 2028-2033, terms 2036, 2045, $67 million of Series 235, serials 2022-2028, $45.8 million of Series 237, serials 2025-2030. Barclays Capital Inc. will run the books.
The San Diego Unified School District is set to price on Wednesday $240 million of tax and revenue anticipation notes. BofA Securities is head underwriter.
The Texas Municipal Power Agency (A1///) is set to price on Tuesday $201.6 million of transmission system revenue refunding bonds. BofA Securities is lead underwriter.
The State Building Authority, Michigan (Aa2//AA-/) is set to price on Tuesday $199.76 million of 2021 revenue bonds Series I (Facilities Program), serials 2021-2026, terms 2038, 2039, 2040, 2041, 2046, 2051, 2056. Siebert Williams Shank & Co., LLC is bookrunner.
Chester County Industrial Development Authority (Aa2///) is set to price on Wednesday $146.9 million of Longwood Gardens, Inc. Project sustainability revenue Bonds, Series 2021. Morgan Stanley & Co. LLC is head underwriter.
The Nebraska Investment Finance Authority (/AA+//) is set to price on Thursday $129.1 million of single-family housing refunding revenue bonds 2021 Series C (Non-AMT) social bonds. J.P. Morgan Securities LLC is lead underwriter.
Collin County, Texas, (Aaa/AAA//) is set to price on Tuesday $103 million of limited tax permanent improvement and refunding bonds, Series 2021, serials 2022-2041. Citigroup Global Markets Inc. will run the books.
The Godley Independent School District (Aaa///) (PSF guarantee) is set to price $94.6 million of unlimited tax school building bonds on Tuesday. Serials 2027-2051. RBC Capital Markets is head underwriter.
In the competitive market Monday, Wayzata, Minnesota, is set to sell $135.75 million of taxable general obligation school building and alternative facilities refunding bonds, Series 2021A (Minnesota School District Credit Enhancement Program) at 11 a.m. eastern.
On Tuesday, Santa Clara, California, (/AA+/AA/) is set to sell $337.7 million of lease revenue bonds at 11:45 a.m.
Hillsborough County, Florida, (Aaa/AA+/AAA/) is set to sell $152 million of utility revenue bonds at 10:30 a.m. and $17.7 million of utility revenue refunding bonds at 11 a.m.
Clark County SD, Nevada, (A1/A+//) is set to sell $200 million of general obligation bonds at 11:30 a.m.
Seattle (Aa2/AA//) is set to sell $261.6 million of municipal light and power improvement and refunding revenue bonds at 10:45 a.m.
On Wednesday, Portland Public School District #1J (Aa2/AA//) is set to sell $401.9 million of taxable full faith and credit bonds at 11 a.m.
In Barclays’ view, tax-exempts have been underperforming because of a combination of factors.