Overview
The bond market is showing some relief this morning on news that discussions are underway between the US and Iran following the US reportedly calling-off a major attack on the Islamic Republic. After touching $90 last week, ICE Brent Futures are now back in the low $80’s this morning. However, anxieties in the capital markets remain high following last week’s Fed meeting, which left many market participants unconvinced of the Fed’s undertaking to fight inflation. The impression of a stable labor market combined with elevated energy prices continues to feed a narrative for Fed rate hikes later this year. Fed funds futures are now pricing in the likelihood of a Fed rate hike of 25bp at over 90% by the October 27-28 meeting; which, as of early last week, was thought to occur as soon as September.
Implied Overnight Rate & Number of Hikes/Cuts
Insights and Strategy
In response to last week’s Fed meeting, the Treasury curve fell for maturities shorter than five-years as markets trimmed expectations of future rate hikes while the long end saw rates rise due to long-term inflation expectations. Overall, the Treasury curve steepened while municipals demonstrated more resolve on the short-end of the curve and only sold-off slightly, by about three-basis points, on the long-end. Inflation concerns with volatile energy prices continue to hold the long-end of the Treasury curve above 5% for maturities past 15-years. The slope at the long-end of the municipal yield curve, past 20-years, remains relatively flat with a total slope of 30 bps from 21-30-years. Due to this flat tail, municipal bond investors can currently buy 20-year maturities that yield 91% of the 30-year curve versus 75% for 10-year maturities.
Over the past week, Municipal/Treasury ratios have generally declined (richened), with the largest changes occurring from on the long-end. However, over the past month we have seen a notable cheapening in ratios, particularly around the 10-year tenor. One-year ratios are now just above 60% and 10-year ratios are now over 70% of Treasuries. However, 20-year ratios remain just below 80% and 30-year ratios are well below 90% of Treasuries. For investors seeking to maximize curve positioning with relative value, the 20-year part of the municipal yield curve remains attractive with steeper slopes. Nevertheless, the shorter end of the yield curve has recently seen steeper slopes with 84 bps of slope from one to 10 years and 50 bps of slope from four to eight years. Although ratios past 20-years are more attractive, relative to Treasuries, the yield curve is very flat over these longer tenors.
The Municipal the new issue calendar ramps-up this week with US state and local governments expected to sell around $18 billion of bonds. Notable deals include: the City of New York, NY, which plans to sell $1.5 billion; Intermountain Healthcare Obligated Group has scheduled $1.11 billion; San Francisco City & County Public Utilities Commission plans to sell $814.4 million in Wastewater Revenue Bonds; and, Black Belt Energy Gas District is expected to bring $800 million to the market. Last week, investors added approximately $761 million to municipal bond mutual funds, up from $174 million the prior week, according to LSEG Lipper data. Furthermore, redemptions and maturities in the next 30-days are expected to total $32.5 billion, according to data compiled by Bloomberg. Overall, investors continue to support munis, but new issue pricings remain in focus.
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