Munis little changed to start March, USTs weaker

Bonds

Municipals were little changed to kick off the month, while U.S. Treasuries were weaker and equities ended mixed.

The three-year muni-UST ratio was at 60%, the five-year at 62%, the 10-year at 65% and the 30-year at 90%, according to Refinitiv MMD’s 3 p.m. ET read. ICE Data Services had the three at 64%, the five at 63%, the 10 at 68% and the 30 at 92% at 4 p.m.

The ISM manufacturing report rattled markets. Despite posting a modest increase, the index “remains in contraction territory,” said Edward Moya, senior market analyst for the Americas at OANDA, “but prices paid came in hotter, which signals rising costs are coming.”

The argument for more rate hikes, he said, “is elevated as material costs appear poised to rise and as the Fed has yet to see a true demand slowdown.”

“March Mayhem could see tremendous volatility once we get a look at the February labor market report,” he noted. “The February inflation report is also expected to show modest decline, but any hot pricing data could keep the bond market selloff going.”

The report was “a setback” for the Federal Reserve, said José Torres, senior economist at Interactive Brokers. “Manufacturing ISM data shows the resurgence in price increases is strong while manufacturing employment is contracting,” he said.

“While still assessing [Tuesday’s] batch of troubling economic data, investors are facing the cold and somewhat contradictory reality of a continuing decline in manufacturing, a big jump in input costs and a loss of jobs,” Torres said.

Municipals are historically strong on a relative basis, even though some absolute yields still hover near decade highs, according to a monthly report from Morgan Stanley Wealth Management.

“It’s understandable why some investors are taking a pass on uncertainty and instead locking in rates available today,” investment strategists Matthew Gastall and Daryl Helsing said in the report. 

For some, that could mean looking at taxable municipals as the value propositions for taxable instruments, according to the strategists.

“This is particularly true for participants in low federal [income tax] brackets and/or low-tax states,” they said. “Exemptions for higher-bracket investors may still make municipals attractive despite these relative relationships, but those who benefit less from exclusions may currently earn more when investing in taxable bonds, which include certain municipals.”

Crossover investors, who often have short-term professional outlooks on the market, can quickly reposition or crisscross between the two markets to capitalize on perceived opportunities, Gastall and Helsing said. 

“These symbiotic interconnectivities have helped to restore balances between the taxable and tax-exempt arenas for decades,” they wrote. “If the offered yields on U.S. Treasuries continue to rise, municipals may have little choice but to follow their lead — possibly more aggressively — due to their current standing as being already healthily valued,” the analysts said. 

That relationship, they said, warrants a position of short-term caution — especially when considering that new-issue supply is also accelerating for the spring.

High-bracket investors might want to leverage some caution with tax-exempt bonds, since the crisscross between taxable and tax-exempt bond yields may become tighter, and pull municipal yields higher, if U.S. Treasury rates rise while tax-exempt supply accelerates. 

“Consequently, we feel it’s advantageous that participants maintain some dry powder in front-end cash,” they suggested. “When investment opportunities surface, recall that tight credit spreads and current recession risks encourage a high credit-quality investment advocacy.”

They recommend clients consider a diversified blend of securities.

At the same time, moderating inflation, recession risks, low supply, and healthy reinvestment demand have helped bolster this year’s performance, the said.

“Consequently, it appears that it was advantageous for investors to add exposure last spring and fall, while the current juncture is likely accommodative for completing portfolio reviews and clean-up swaps,” they wrote. 

“For those participants looking to lock in yield, we suggest that low-bracket and/or low tax state investors embrace a heightened focus on taxable securities, which may include certain municipals,” they added. 

Turning to yield curve positioning, the team favors a bifurcated approach that focuses on high coupon-paying bonds with both short final maturities alongside kicker structures. 

“Those investors looking to add duration may wish to consider doing so with bonds that have longer first call dates, but still capped final maturities laddered in yield curve sectors that are appropriate for risk tolerances,” they wrote. 

Overall, they warned investors to keep in mind that interest rates may rise again on higher energy prices, a weaker U.S. dollar, transitioning inflationary expectations, and many other factors.

Returns may continue to struggle in the near-term, said Cooper Howard, a fixed income strategist focused on munis at Charles Schwab.

“Returns declined in February due to an increase in supply, concerns about Federal Reserve policy, and overly rich valuations to start the month,” he said. “More pain may be ahead because, historically, March has been the worst month for returns due to investors selling munis to raise cash to meet tax liabilities in April.”

Meanwhile, credit quality is strong but has likely peaked. There may be “potential credit headwinds on the horizon if the economy slows because tax revenues lag economic growth,” he said. Even if revenues falter, Howard doesn’t anticipate “widespread downgrades, as many states have used the surge in revenues to pad their financial position.”

Outflows returned, with the Investment Company Institute reporting investors pulled $1.148 billion from mutual funds in the week ending Feb. 22, after $931 million of inflows the previous week.

Exchange-traded funds saw outflows of $298 million after $160 million of outflows the week prior, per ICI data.

In the primary market Wednesday, Goldman Sachs & Co. priced for the Southeast Energy Authority, Alabama, (A1///) $675.605 million of Project No. 5 commodity supply revenue bonds, with 5s of 7/2024 at 4.30% and 5.25s of 2028 at 4.43%, make whole call.

RBC Capital Markets priced for the Texas Department of Housing and Community Affairs (Aaa/AA+//) $230 million of non-AMT residential mortgage revenue bonds, Series 2023A with 3.2s of 7/2024 at par, 5.5s of 1/2028 at 3.20%, 5.5s of 7/2028 at 3.25%, 3.85s of 1/2033 at par, 3.9s of 7/2033 at par, 4.3s of 1/2038 at par, 5.125s of 1/2048 at 4.89%, 5.25s of 1/2053 at 4.94% and 5.5s of 7/2053 at 4.71%, callable 7/1/2032.

BofA Securities priced for the Illinois Finance Authority (Aa2/AA-/AA+/) $182.930 million of revenue bonds, Series 2023A, with 5s of 5/2030 at 2.75%, 5s of 2033 at 2.82%, 5s of 2038 at 3.54%, 5s of 2043 at 3.93%, 5.25s of 2048 at 4.03% and 5.25s of 2054 at 4.13%, callable 5/15/2033.

In the competitive, Oyster Bay, New York, sold $162.040 of water district notes, Series 2023, to Wells Fargo Bank, with 5s of 3/2024 at 3.08%.

Cambridge, Massachusetts, (/AAA//) sold $93.625 million of GOs to Jefferies, with 5s of 2/2024 at 3.00%, 5s of 2028 at 2.50%, 5s of 2033 at 2.53%, 5s of 2038 at 3.22% and 4s of 2043 at 4.07%, callable 2/15/2033.

Secondary trading
Triborough Bridge and Tunnel Authority 4s of 2024 at 3.01%. Washington 5s of 2025 at 3.05%. Baltimore County, Maryland, 5s of 2026 at 2.88% versus 2.70% on 2/21.

California 5s of 2028 at 2.69%. NYC Municipal Water Finance Authority 5s of 2030 at 2.68%-2.65% versus 2.63%-2.58% on 2/21. Energy Northwest, Washington, 5s of 2032 at 2.79%.

University of California 5s of 2037 at 3.23%-3.22% versus 3.29% on 2/23 and 3.29% original on 2/16. Virginia Public Building Authority 5s of 2038 at 3.47%-3.46%. Huntsville, Alabama 5s of 2039 at 3.55%.

University of California 5s of 2052 at 3.30%. Illinois Finance Authority 5s of 2052 at 4.40% versus 4.37% Monday and 4.40%-4.35% on 2/22.

AAA scales
Refinitiv MMD’s scale was cut up to one basis point. The one-year was at 3.03% (unch, no March roll) and 2.95% (unch, no March roll) in two years. The five-year was at 2.64% (unch, no March roll), the 10-year at 2.59% (unch, no March roll) and the 30-year at 3.56% (unch) at 3 p.m.

The ICE AAA yield curve was cut up to two basis points outside one-year: 3.08% (-2) in 2024 and 3.01% (flat) in 2025. The five-year was at 2.67% (+1), the 10-year was at 2.63% (+2) and the 30-year yield was at 3.61% (+2) at 4 p.m.

The IHS Markit municipal curve was unchanged: 3.04% in 2024 and 2.95% in 2025. The five-year was at 2.62%, the 10-year was at 2.58% and the 30-year yield was at 3.58% at a 4 p.m. read.

Bloomberg BVAL was cut up to a basis point: 3.15% (unch) in 2024 and 2.93% (unch) in 2025. The five-year at 2.63% (+1), the 10-year at 2.63% (+1) and the 30-year at 3.60% (unch).

Treasuries were weaker.

The two-year UST was yielding 4.887% (+10), the three-year was at 4.612% (+11), the five-year at 4.269% (+10), the seven-year at 4.171% (+10), the 10-year at 3.992% (+10), the 20-year at 4.166% (+7) and the 30-year Treasury was yielding 3.955% (+6) at 4 p.m.

Primary to come
The Port of Portland, Oregon, is set to sell $583 million of Series 29 Port International airport revenue green bonds subject to the alternative minimum tax on Thursday. Goldman is the senior manager on the deal, which is rated AA-minus by both S&P Global Ratings and Fitch Ratings.

The Washington Metropolitan Area Transit Authority in the District of Columbia is planning a $392 million Thursday sale of Series 2023 dedicated revenue green bonds. RBC Capital Markets is the senior bookrunner. The bonds are rated AA by S&P and Fitch and AA-plus by Kroll Bond Rating Agency.

Portland Community College, Oregon, plans a $225 million sale of Series 2023 general obligation bonds. Rated AA-plus by S&P, the bonds are being senior managed by Piper Sandler.

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