Overview
This morning’s announcement of a reprieve in the trade war between the US and China sparked a seven-basis point increase in the 10-year Treasury yield as traders pushed back the timing of possible interest-rate cuts. The trade war has been the biggest driver of rates in the capital markets this year, marking a significant shift from the previous focus on the Fed. Last week, the Fed held rates steady at 4.25% to 4.5% and cited the trade talks as a key factor amid concerns of increased unemployment and higher inflation. Volatility from the trade war has been elevated in the Treasury bond market with trading surging 25% in April to a record $1.323 trillion in average daily turnover, which almost doubled to $2.44 billion on the peak day with trade war volatility driving position unwinds.
Not surprisingly, uncertainty in the municipal bond market also remains uncharacteristically high. Last week, LSEG Lipper Global Fund Flows reported that investors added $1.1 billion to municipal bond funds. As a result, technical conditions improved in the muni market last week as robust supply was met with solid demand. Long-term muni funds gained $597 million while intermediate funds saw inflows of $96 million and high-yield funds added $348 million. Overall, the fund flows point to risk-on as investors migrate to the long-end of the curve and riskier assets. From the perspective of the Charlotte trade desk, trades this morning have been a little soft but ratios have recently compressed and inventory struggles to keep pace with demand.
Although the Treasury bond yield curve has steepened slightly over the last week, with the long-end selling-off five basis points, the municipal bond yield curve has responded with a two to four basis point parallel shift lower. The steepening Treasury bond yield curve combined with mixed inflation signals greatly complicates the timing of future policy moves. Further adding to the uncertainty, the Treasury curve has sold-off 18-20 bps in the policy sensitive 2-4 year portion of the curve. This move points to potential flattening of Treasury bond yields as investors struggle with where to position.
Ratios and Strategy
Slopes along the municipal bond yield curve progressively steepen from 6 to 17 years with the 15 to 17-year portion of the curve having the steepest slope of 11bps/year. The 15-17 year portion of the municipal curve also offers approximately 90% of the yield on the 30-year muni maturity and approximately 80% of 20-year Treasury bond yields. However, yields flatten-out meaningfully on the long-end with slopes of one to three basis points over the last nine-years.
Over the past month, Muni/Treasury ratios have compressed by over nine percentage points on the short-end. Ratios have also compressed on the long-end, but at about half the rate of the short-end with 30-year ratios compressing 4.6% over the past month. Relative to 10-year historic means, ratios have once again become rich with the greatest disparity on the short-end with historic ratios of 95.72% versus 70.2% currently. As in the past, these tighter ratios will weigh on investor decisions and we may see stronger sympathies by munis to moves in the Treasury bond market.
Herbert J. Sims & Co. Inc. is a SEC registered broker-dealer, a member of FINRA, SIPC. The information contained herein has been prepared based upon publicly available sources believed to be reliable; however, HJ Sims does not warrant its completeness or accuracy and no independent verification has been made as to its accuracy or completeness. The information contained has been prepared and is distributed solely for informational purposes and is not a solicitation or an offer to buy or sell any security or instrument or to participate in any trading or investment strategy, and is subject to change without notice. All investments include risks. Nothing in this message or report constitutes or should be construed to be accounting, tax, investment or legal advice.
