This morning municipal bonds are selling-off following Friday’s downgrade of the US Treasury by Moody’s from ‘AAA’ to ‘Aa1.’ In early trading yields extended over 5% for 20 and 30-year Treasury bonds, although yields have since settled back under 5% for both tenors. Moody’s downgrade was prompted by their concern of a decade of increasing debt and interest payments to levels significantly higher than similarly rated sovereigns and by successive US administrations that failed to agree with Congress on measures to reverse the trend. In addition, Moody’s commented the ratio of total US public debt to the size of the economy has reached 98% of GDP in 2024 and anticipates the federal debt burden will reach 134% of GDP by 2035. Moody’s also changed its outlook on the US economy from negative to stable and commented that it expects US GDP growth to slow in the short-term as the economy adjusts to higher tariffs, but that it does not expect long-term growth to be significantly affected.
Ratios and Strategy
The change in Treasury ratings puts relative value with the municipal market into question with the possibility to disrupting traditional relationships between the two markets. Although the impact on municipals is far more muted than the impact on Treasury Bonds, we are still seeing municipals selling-off 2.5 bps across the 20 to 30-year tenors versus Treasury bonds selling-off 7 to 8 bps in the same range. As a result, muni/Treasury ratios continue to grind lower with ratios now in the high 60’s on the short-end of the curve.
On a relative basis, the draw to longer durations is decreasing as the justification for extension shifts to the stability of municipal credit ratings rather than improved ratios. As an asset class, municipal bonds now offer greater credit appeal versus similarly or even lower rated Treasury obligations. However, with 20-year municipals yielding 85% of their Treasury equivalents and 30-year municipals yielding over 90% of equivalent Treasury bonds, there is still a progressive benefit to the tax exemption. From the perspective of the Charlotte trading desk, tighter ratios make it more difficult to bid aggressively on secondary offerings with a narrower margin for error.
Unlike recent weeks, Treasury bonds and municipals are shifting in a similar manner with intermediate yields adjusting slightly lower while longer yields adjust higher resulting in a similar steepening in both curves. The municipal curve starts to steepen at around the 9-year maturity with steepening extending out to the 15 to 17 year portion of the curve. Overall, there is over 90 bps of steepening in this range with a slope of approximately 11bps per year, meaning that investors are rewarded for assuming duration risk in this part of the curve. In addition, the 17 year portion of the municipal curve also offers 90% of the yield on the 30-year municipal maturity and approximately 80% of 20-year Treasury bond yields. However, yields flatten-out meaningfully on the long-end with slopes of just a few basis points per year over the last 10-years.
Last week, LSEG Lipper Global Fund Flows reported that investors added $769 million to municipal bond funds. Long-term muni funds gained $337 million while intermediate funds saw inflows of $161 million and high-yield funds added $140 million. Overall, the fund flows point to less risk appetite as investors return to the safety of intermediate investment-grade bonds. In addition, municipal issuance remains brisk offering incoming money a variety of choice with $12.7 billion of new issuance over this week from issuers ranging from State of Kansas to local school districts.
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.
May 19, 2025 | Timothy Iltz
Overview
This morning municipal bonds are selling-off following Friday’s downgrade of the US Treasury by Moody’s from ‘AAA’ to ‘Aa1.’ In early trading yields extended over 5% for 20 and 30-year Treasury bonds, although yields have since settled back under 5% for both tenors. Moody’s downgrade was prompted by their concern of a decade of increasing debt and interest payments to levels significantly higher than similarly rated sovereigns and by successive US administrations that failed to agree with Congress on measures to reverse the trend. In addition, Moody’s commented the ratio of total US public debt to the size of the economy has reached 98% of GDP in 2024 and anticipates the federal debt burden will reach 134% of GDP by 2035. Moody’s also changed its outlook on the US economy from negative to stable and commented that it expects US GDP growth to slow in the short-term as the economy adjusts to higher tariffs, but that it does not expect long-term growth to be significantly affected.
Ratios and Strategy
The change in Treasury ratings puts relative value with the municipal market into question with the possibility to disrupting traditional relationships between the two markets. Although the impact on municipals is far more muted than the impact on Treasury Bonds, we are still seeing municipals selling-off 2.5 bps across the 20 to 30-year tenors versus Treasury bonds selling-off 7 to 8 bps in the same range. As a result, muni/Treasury ratios continue to grind lower with ratios now in the high 60’s on the short-end of the curve.
On a relative basis, the draw to longer durations is decreasing as the justification for extension shifts to the stability of municipal credit ratings rather than improved ratios. As an asset class, municipal bonds now offer greater credit appeal versus similarly or even lower rated Treasury obligations. However, with 20-year municipals yielding 85% of their Treasury equivalents and 30-year municipals yielding over 90% of equivalent Treasury bonds, there is still a progressive benefit to the tax exemption. From the perspective of the Charlotte trading desk, tighter ratios make it more difficult to bid aggressively on secondary offerings with a narrower margin for error.
Unlike recent weeks, Treasury bonds and municipals are shifting in a similar manner with intermediate yields adjusting slightly lower while longer yields adjust higher resulting in a similar steepening in both curves. The municipal curve starts to steepen at around the 9-year maturity with steepening extending out to the 15 to 17 year portion of the curve. Overall, there is over 90 bps of steepening in this range with a slope of approximately 11bps per year, meaning that investors are rewarded for assuming duration risk in this part of the curve. In addition, the 17 year portion of the municipal curve also offers 90% of the yield on the 30-year municipal maturity and approximately 80% of 20-year Treasury bond yields. However, yields flatten-out meaningfully on the long-end with slopes of just a few basis points per year over the last 10-years.
Last week, LSEG Lipper Global Fund Flows reported that investors added $769 million to municipal bond funds. Long-term muni funds gained $337 million while intermediate funds saw inflows of $161 million and high-yield funds added $140 million. Overall, the fund flows point to less risk appetite as investors return to the safety of intermediate investment-grade bonds. In addition, municipal issuance remains brisk offering incoming money a variety of choice with $12.7 billion of new issuance over this week from issuers ranging from State of Kansas to local school districts.
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.