Munis sell off as outflows return

Municipals sold off Thursday, following U.S. Treasury losses after more economic data suggested the U.S. economy is strong enough to potentially warrant more rate hikes in the fall. Equities ended down.

Ahead of Friday’s jobs report, Wall Street is “watching a global bond market selloff get uglier as U.S. stocks waver ahead of massive earnings from Apple and Amazon,” said Edward Moya, senior market analyst at The Americas OANDA. Coupled with the Bank of England signaling more tightening is ahead , recent economic data has confirmed the U.S. economy remains resilient, he said, which fanned more concerns over Fed policy uncertainty.

“Both initial jobless claims still remain low and the ISM services employment component supports the argument that the Fed might need to deliver more tightening in November,” he noted.

Triple-A yields rose six to 12 basis points, depending on the scale, Thursday, while UST yields rose as much as 14 at 30 years on the headlines.

Municipal bond mutual fund outflows returned with Refinitiv Lipper reporting investors pulled $989.852 million from funds for the week ending Wednesday following $552.219 million of inflows the previous week. Exchange-traded funds saw outflows of $675.259 million after inflows of $249.771 million in the previous week.

For muni mutual funds, even though “net flows have been bouncing around — a little bit positive, a little bit negative — the gross purchase flows through the end of June had been running pretty low,” said Pat Luby, a CreditSights strategist.

So “the fact that mutual fund flows have not been seriously negative has more been a function of a slowdown in redemptions,” he said.

With the volatility seen in the UST market, he believes that influences the confidence level of individual investors.

“We’ve got a lot a lot of turmoil in the marketplace,” he said.

Luby noted the timing of the large outflows from muni mutual funds is somewhat surprising given the significance of the Aug. 1 redemption flows.

This, he said, is a “yellow flag,” particularly with ETFs. He said the uptick in outflows from ETFs suggests that investor confidence is waning.

Over the last decade, August, September and October have been weak months for the muni market.

This is not “cataclysmic but it’s a reminder that this is a time of year that investors shouldn’t be expected to put new money to work in the new market,” he said.

The weight of issuance in the near term has taken over what was a stable tone as “available cash is using its leverage to negotiate wider yields and spreads,” said Kim Olsan, senior vice president of municipal bond trading at FHN Financial.

For a fourth straight day, a weaker UST session “piggybacked on corrective municipal ratios to send yields higher — a counterintuitive move given the scope of reinvestment demand this month,” she said.

The two-year muni-to-Treasury ratio Thursday was at 65%, the three-year at 66%, the five-year at 66%, the 10-year at 66% and the 30-year at 87%, according to Refinitiv MMD’s 3 p.m. read. ICE Data Services had the two-year at 65%, the three-year at 67%, the five-year at 66%, the 10-year at 68% and the 30-year at 90% at 4 p.m.

If muni-UST ratio relative values were higher, she said there would have been a more limited response.

Generic muni yields have risen 10 to 15 basis points since the end of July, as Texas supply is piling on an outsized reaction, she noted.

New-issue PSF-insured school spreads have “reached +50/MMD in intermediate maturities — nearby those of AA-rated hospital names,” she said.

A trade of Harris County, Texas, Health (Memorial Herman) (Aa3/A+/) 5s due 2029 “was spread +43/MMD while various PSF pricings in the same maturity were spread in the +30/MMD range,” according to Olsan.

Buyers could be given more high-grade opportunities that “are certainly an infrequent occurrence in the sector” if more supply forces wider concessions, she said.

Broadly, she said more volatility is expected based on recent metrics “as buyers navigate the Fed’s anticipated path in light of strong economic data and growing UST supply.”

Floating-rate munis “have had a rollercoaster ride since tax season ended, with 100+ basis point moves in some weeks — current levels suggest more money-market demand has developed with a precipitous drop in yields in the recent week,” she said.

Similarly, bid list volume is “holding on the upper ends, averaging $1.1 billion per day,” she noted.

At minimum, she said “the balance is tilted toward more favorable spreads” as August continues.

The first half of 2023 saw a net negative supply of bonds, thanks to increased demand and a significant drop in new issuance. Jeff Timlin, a managing partner at Sage Advisory, offered an explanation for some of the recent demand: “summer seasonal” effects.

“On average, June, July, and August experience 60% of all maturity and coupon payments that come due, which artificially props up demand and often leads to a temporary period of overvaluations,” Timlin wrote.

The summer seasonal period will be ending soon, Timlin said, which will give investors “a better entry point to allocate capital to the municipal market.” Investors will also benefit from slightly more supply in the second half of the year; although it will still be net negative, technical strength should diminish, Timlin said.

Absolute and relative valuations typically adjust during the second half of the year, and Timlin said this may “enhance the expected return outcome and tax-free income generation.” Timlin doesn’t expect to see much from seasonal reinvestment effects until January.

Investors may also benefit from the Fed letting up on interest rates, Timlin said. However, if the Fed’s rate hikes trigger a recession, bonds will likely outperform, Timlin said, “as risk assets endure the most of fund outflows that coincide with negative returns.”

In the primary market Thursday, Siebert Williams Shank & Co. priced for the Crowley Independent School District, Texas, (Aaa//AAA/) $433.485 million of PSF-insured unlimited tax school building bonds, Series 2023, with 5s of 2/2024 at 3.52%, 5s of 2028 at 3.11%, 5s of 2033 at 3.19%, 5s of 2038 at 3.59%, 5s of 2043 at 3.97%, 5s of 2048 at 4.17%, 5.25s of 2053 at 4.22% and 4.25s of 2053 at 4.54%, callable 2/1/2033.

BOK Financial Securities priced for the Oklahoma Water Resources Board (/AAA//) is set to price Tuesday $176.805 million of state loan program revenue bonds, Series 2023B, with 5s of 10/2024 at 3.22%, 5s of 2028 at 2.80%, 5s of 2033 at 2.86%, 5s of 2038 at 3.28%, 4s of 2043 at 4.07%, 4s of 2048 at 4.23% and 4.125s of 2053 at 4.32%, callable 10/1/2033.

Secondary trading
Connecticut 5s of 2024 at 3.42%. NYC 5s of 2024 at 3.33%. Washington 5s of 2025 at 3.23% versus 3.15% Wednesday and 2.95% original on 7/26.

Massachusetts 5s of 2028 at 2.82% versus 2.72% Tuesday. Florida 5s of 2028 at  2.85% versus 2.65% on 7/12. California 5s of 2029 at 2.75%-2.76%.

Board of Regents of the University of Texas System 5s of 2031 at 3.09%-3.07%. Santa Clara Valley Transportation Authority, California, 5s of 2034 at 2.66% versus 2.57%-2.59% Wednesday and 2.46% on 7/26. Arlington, Texas, 5s of 2035 at 3.12% versus 2.94% on 7/18.

Massachusetts 5s of 2048 at 4.03%-4.02% versus 3.78%-3.79% Monday and 3.76% on 7/28. Baltimore County, Maryland, 5s of 2049 at 3.90% versus 3.60%-3.61% on 7/26 and 3.58% on 7/24. NYC TFA 5s of 2053 at 4.20% versus 4.05%-4.12% Wednesday and 4.03% Tuesday.

AAA scales
Refinitiv MMD’s scale was cut six to 12 basis points: The one-year was at 3.33% (+6) and 3.17% (+8) in two years. The five-year was at 2.84% (+8) , the 10-year at 2.77% (+10) and the 30-year at 3.73% (+12) at 3 p.m.

The ICE AAA yield curve was cut eight to 10 basis points: 3.31% (+8) in 2024 and 3.19% (+8) in 2025. The five-year was at 2.81% (+9), the 10-year was at 2.75% (+10) and the 30-year was at 3.74% (+10) at 4 p.m.

The S&P Global Market Intelligence (formerly IHS Markit) municipal curve was cut eight to 12 basis points: 3.34% (+8) in 2024 and 3.17% (+8) in 2025. The five-year was at 2.84% (+8), the 10-year was at 2.78% (+11) and the 30-year yield was at 3.72% (+12), according to a 3 p.m. read.

Bloomberg BVAL was cut seven to 11 basis points: 3.22% (+7) in 2024 and 3.12% (+8) in 2025. The five-year at 2.78% (+8), the 10-year at 2.73% (+10) and the 30-year at 3.73% (+11) at 4 p.m.

Treasuries were weaker.

The two-year UST was yielding 4.884% (flat), the three-year was at 4.578% (+3), the five-year at 4.296% (+7), the 10-year at 4.181% (+11), the 20-year at 4.482% (+13) and the 30-year Treasury was yielding 4.300% (+14) near the close.

Mutual fund details
Refinitiv Lipper reported $989.852 million of outflows from municipal bond mutual funds for the week ending Wednesday following $552.219 million of inflows the week prior.

Exchange-traded muni funds reported outflows of $675.259 million after inflows of $249.771 million in the previous week. Ex-ETFs muni funds saw outflows of $314.593 million after inflows of $302.448 million in the prior week.

Long-term muni bond funds had outflows of $695.590 million in the latest week after inflows of $591.430 million in the previous week. Intermediate-term funds had $51.416 million of inflows after inflows of $185.821 million in the prior week.

National funds had outflows of $883.558 million after inflows of $611.918 million the previous week while high-yield muni funds reported outflows of $48.497 million after inflows of $223.444 million the week prior.

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