USTs rally on intensifying recession concerns, munis underperform


Municipals were firmer Wednesday but underperformed a U.S. Treasury rally as traders look to the UST curve inversion as further signs of a looming recession, leading equities to close in the red for another session.

“Stocks declined as investors fixated over how bad of a recession will hit the U.S. economy and weighed on geopolitical risks,” said Edward Moya, OANDA. ”The economy is entering slowdown mode as final Q3 nonfarm productivity data was revised higher and labor costs were significantly revised lower.”

Triple-A muni yields fell two to four basis points, nudging the 10-year muni closer to 2.50% and the 30-year below 3.50%. UST yields fell 10 to 13 basis points across the curve. The U.S. 10-year yield fell 12 basis points to 3.414%, while the 30-year UST also fell below 3.5% to close the session at 3.422%. The 2s10s spread fell to negative 80-plus basis points as did the 2s30s.

“Yield curve inversion deepens and nears a four-decade low which is clearly setting up this economy for a recession that won’t be a mild one,” Moya said.

Municipal to UST ratios out long rose again. The three-year muni-UST ratio was at 61%, the five-year at 68%, the 10-year at 74% and the 30-year at 101%, according to Refinitiv MMD’s 3 p.m. read. ICE Data Services had the three at 59%, the five at 64%, the 10 at 74% and the 30 at 98% at a 4 p.m. read. 

In the primary Wednesday, Wells Fargo Bank priced for the Virginia Small Business Financing Authority (Aaa///) $125 million of Pure Salmon Virginia LLC Project environmental facilities revenue bonds, Series 2022, with 3.5s of 11/2052 with a mandatory tender date of 11/1/2023 at par, callable 8/1/2023.

Outlook for 2023 improving for munis
Munis are set to end the year in “deep negative territory,”noted Vikram Rai, head of Citigroup Global Market’s Municipal Strategy group during a 2023 outlook call. However, he is bullish on munis in the near term, as historically, December and January have been supportive as coupon payments and redemptions grow.

Taxable municipal performance this year has been “heartbreaking,” he said.

“For the longest time, we would brag about taxables, but this year, they have done even worse than most tax-exempts,” he said.

Rai said taxables’ negative performance isn’t due to a supply-demand imbalance because there’s hardly any supply. He believes the negative performance can be attributed to mainly the duration and some illiquidity.

Fed funds are up 375 basis points year-to-date, with economists forecasting another 100 basis points before the Fed pauses.

“This is no surprise, given all that has gone on, that Treasuries have created an incredibly wide range,” Rai said. The 10-year UST range is around 273 basis points, the widest since 1980 when 10-year UST yields were about 8%.

Munis have followed UST volatility and triple-A yields have traded in a 236 basis point range, he said. 

Rai noted there are similarities between the market environment now versus the market environment in the 1970s and 1980s, but this hiking is “very unique.”

If the downdraft and inflation continue, he expects the rate volatility to subside.

Heading into 2023, Cooper Howard, a fixed income strategist focused on munis at Charles Schwab said, “2023 should be the year where muni bonds come back in vogue.”

“While 2022 was a brutal year for the muni market but we expect that to change in 2023,” he said. “For the first time in a long time, investors can earn appealing income on their muni bond portfolio which should begin to attract investors and bode well for total returns.”

Howard said that issuance will likely remain subdued, which is supportive of total returns.

“Issuance should continue to remain lower than average assuming that interest rates don’t fall substantially,” he said. “Historically, higher interest rates have resulted in lower issuance.”

Moreover, he said, “state and local government coffers are at record levels which lessens the needs to borrow.”

Lower issuance combined with increased demand should help muni returns in 2023, Howard noted, adding that “a positive credit outlook should also bode well for demand in 2023.”

State and local government credit quality continued to improve in 2022, and he expects “it to remain strong in 2023.”

State tax revenues have “surged to record levels and state rainy day funds are at record levels as well,” he said.

The improved financial conditions for state and local governments, he said, “have translated into ratings upgrades.”

“Defaults remain low and we don’t anticipate they will substantially increase in 2023,” Howard said.

“Although credit quality is high, we believe that we are at the peak in the economic cycle and if the economy continues to run below-trend growth, the pace of growth for state and local government tax revenues should slow too,” he said. “This likely won’t lead to an increase in defaults or downgrades but the pace of upgrades should slow.”

Howard said he’s “more cautious” on issuers that are lower rated and have revenue streams closely tied to economic growth.

Fund outflows continue
Outflows intensified with the Investment Company Institute reporting that investors pulled $2.488 billion from mutual funds in the week ending Nov. 30 after $1.733 billion of outflows the previous week.

Exchange-traded funds saw another week of inflows at $1.386 billion after $877 million of inflows the week prior, per ICI data.

Informa: Money market munis see outflows
Tax-exempt municipal money market funds saw $2.63 billion of outflows the week ending Tuesday, bringing the total assets to $107.09 billion, according to the Money Fund Report, a publication of Informa Financial Intelligence.

The average seven-day simple yield for all tax-free and municipal money-market funds rose to 1.49%,

Taxable money-fund assets inflows of $62.18 billion to end the reporting week at $4.552 trillion of total net assets. The average seven-day simple yield for all taxable reporting funds rose to 3.48%.

AAA scales
Refinitiv MMD’s scale was bumped up to two basis points: the one-year at 2.39% (unch) and 2.41% (unch) in two years. The five-year at 2.47% (-2), the 10-year at 2.53% (-2) and the 30-year at 3.46% (-2).

The ICE AAA yield curve was bumped up to four basis points: 2.39% (-2) in 2023 and 2.42% (-3) in 2024. The five-year at 2.45% (-4), the 10-year was at 2.58% (-3) and the 30-year yield was at 3.49% (-2) at 4 p.m.

The IHS Markit municipal curve was bumped two basis points: 2.37% (unch) in 2023 and 2.41% (-2) in 2024. The five-year was at 2.48% (-2), the 10-year was at 2.54% (-2) and the 30-year yield was at 3.44% (-2) at a 4 p.m. read.

Bloomberg BVAL was two to three basis pointsfirmer: 2.41% (-2) in 2023 and 2.43% (-3) in 2024. The five-year at 2.47% (-2), the 10-year at 2.57% (-3) and the 30-year at 3.44% (-2) at 4 p.m.

Treasuries rallied.

The two-year UST was yielding 4.254% (-12), the three-year was at 3.980% (-13), the five-year at 3.615% (-13), the seven-year 3.535% (-13), the 10-year yielding 3.414% (-12), the 20-year at 3.657% (-12) and the 30-year Treasury was yielding 3.422% (-12) at the close.

Primary to come:
The Los Angeles Department of Water and Power (Aa2/AA+/AA/) is set to price Thursday $400.450 million of water system revenue bonds, 2022 Series D, serials 2023-2042, terms 2047 and 2052. Barclays Capital.

The Adventist Health System/West (/A-/A/) is set to price Thursday $350 million of taxable corporate CUSIPS, Series 2022, serial 2032. RBC Capital Markets.

The Golden State Tobacco Securitization Corporation, California, is set to price Thursday $237.185 million of senior tobacco settlement asset-backed bonds, Series 2022A-1. Jefferies LLC.

The Louisiana Local Government Environmental Facilities and Community Development Authority (Aa1/AAA//) is set to price Friday $209 million of taxable Louisiana Utilities Restoration Corporation Project/ENO storm recovery bonds, Series 2022. J.P. Morgan Securities.

Bucks County Water and Sewer Authority, Pennsylvania, (/A+//) is set to price Thursday $195.745 million of sewer system revenue bonds, Series A of 2022, serials 2023-2047. PNC Capital Markets.

The California Health Facilities Financing Authority (/A-/A/) is set to price Thursday $100 million of Adventist Health System/West revenue bonds, Series 2022A, serial 2028. RBC Capital Markets.

The Triborough Bridge and Tunnel Authority, New York, is set to sell $770 million of payroll mobility tax bond anticipation notes, Series 2022B, at 10:45 a.m. eastern Thursday.

The Cherry Hill Township Board of Education, New Jersey, (Aa2///) is set to sell $300 million of school bonds, Series 2022, at 11 a.m. Thursday.

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