Market Commentary: Back Up the Truck

  • Posted on

By Gayl Mileszko

Market Commentary

Back Up the Truck

Muni yields today are too compelling to pass up.

Quite a few municipal bond traders who lived through the dotcom boom and bust, the global recession, the Meredith Whitney doomsday default predictions, the downgrade of the nation’s sovereign credit rating, and the pandemic are doing cartwheels right now. They have been waiting for years for yields like these.

History usually proves instructive; sometimes it rhymes. Twenty-six years ago in May 2000, municipal bond yields spiked rapidly as the market adjusted to a confluence of factors unrelated to a deterioration in credit quality:

  • Federal Reserve rate tightening
  • Rising Treasury yields
  • Higher oil prices
  • Inflation concerns
  • Money flying into tech companies
  • Heavy issuance

Sound familiar?

The current fed funds rate at 3.75% to 4.00% is likely to rise again by the end of the year. But the federal funds rate back in 2000 had risen over 12 months by 175 basis points to 6.50% in an effort by the Fed to cool an economy that had been expanding for a year and contain inflation pressures. The increase in short-term rates pushed yields higher across fixed income markets. Long-term muni general obligation bond benchmark yields spiked. The selloff in 2000 came near the peak of the Fed tightening cycle. Treasury yields then began trending lower and pulled muni yields down as well. That period, that selloff, at the turn of the century proved to be a very attractive entry point for investors and helped to propel tax-exempt performance during the economic slowdown and recession that followed the tech bust and flight to quality.

  • The current market backdrop feels like something of a déjà vu all over again, as Yogi Berra would say — only without the sheer panic that accompanied market shocks that came in 2001 and again in 2008, 2010-11, and 2020. There is actually no good reason for yields to be where they are, and that’s why they won’t stay here forever. But, unless there is another massive central bank intervention, we will not see nearly two decades of ultralow rates again. Fixed income investors who have been hoping for yields to climb have had their wishes come true now. It’s time to back up the trucks.
    At this writing, the 2-year AAA muni benchmark yield stands at 3.54%, the 10-year at 4.10% and the 30-year at 5.13%. The 2-year Treasury yields 4.86%, the 10-year yields 5.32%, and the 30-year 5.67%.
  • The SIFMA 7-day rate was reset at 3.22% on September 16 and tax-exempt money market funds attracted nearly $4 billion of assets. The rate on September 23 rose to 3.37% and another $3.66 billion rolled in. The rate now sits at 3.93%.
  • Vanguard’s VTEB reported inflows of $4.6 billion in September, including $1.4 billion on Wednesday alone, a record high for the ETF.
  • Municipal bond yields, which have been moving not only in tandem but higher than Treasuries have finally had two days of rallies, shaking off the Treasury shirttail. But the amount of reinvestment money has slowed; redemptions (principal and interest payments) on October 1 fell to $28.3 billion from $42.6 billion on July 1.
  • The Bond Buyer 25-Bond Revenue Index at 5.40% is well above the 4.58% average since 2000, the 4.18% average since 2010, and the 3.81% average since 2020.

Compelling Yields, Attractive Vehicles

Investors looking for income should find this a great time to grab up all the undervalued, well-performing, yield-y bonds that they can in the secondary market. Those investors in high tax states, in particular, need to take a look at all the state tax-exempt bonds available. They are too compelling to ignore. In the primary market, some of the large institutional buyers have been pursuing single-investor placements, seeking preferred structures and prices from underwriters. Retail investors are beginning to pile into the largest muni ETFs; last week, they took in a net of $3 billion. Many are putting low coupon bonds out for bid to make room for ones with higher yields and, since many are priced at significant discount, with great appreciation potential. These bids wanted had par totaling $3.77 billion on Wednesday alone. At nearly $14 billion a week, lists are more than twice the average for the past 3 years. Trading is also heavy: last week saw volume of $109 billion and the prior week totaled $114 billion when the 52-week average is $78.7 billion according to the MSRB.

  • Take a look. In the primary high yield market last week: 
    We at HJ Sims underwrote $30.2 million of non-rated North Carolina Medical Care Commission bonds for Coastal Affordable Senior Housing Foundation, pricing the 2036 term bonds at par to yield 6.75%. The Commission also placed $122.5 million of non-rated 7.375% bonds due in 2051 for University Health Systems of Eastern Carolina.
  • The Central Bradford Authority in Pennsylvania sold $51.7 million of non-rated bonds for The Guthrie Clinic with a 2054 maturity priced at par to yield 7.375%.
  • The Oregon Facilities Authority placed $79.2 million of non-rated Centurion Foundation Legacy Health Portfolio bonds including a 2036 maturity priced at par to yield 5.75%.
  • The Missouri Health and Educational Facilities Authority placed $100 million of non-rated bonds for SSM Health Care Corporation due in 2057 at 7.625%.
  • The Norman Regional Hospital Authority in Oklahoma placed $40 million of non-rated refunding bonds priced with a coupon of 7.50% to yield 7.274%.

In the secondary market last week:

  • $2.68 million of non-rated Arizona charter school bonds due in 2064 traded at $76.727 to yield 6.70%.
  • $600,000 of Ba1 rated California charter school bonds due in 2038 that originally priced in 2018 at $103.34 traded at $80.58.
  • $1.2 million of B+ rated Maryland hospital bonds due in 2040 that originally priced at $111.15 traded at $80.

The Selloff is Overdone

The moves in tax-exempts feel overdone, excessive, given that fundamentals remain strong across the sector. Somewhere around 60% of outstanding muni par is rated between AA and AAA, and the default rate is only 0.75% according to Municipal Market Analytics. That includes Brightline, the privately owned high-speed rail service that filed for bankruptcy last week. Aside from Brightline, though, it is Treasuries that have been getting all the attention in the selloff. This is understandable: the 10-year is now at its highest since 2002, the 30-year rate hit a 24-year high earlier this week, and the Treasury market at $32 trillion is 7 times larger than the muni market. But, looking back to the start of the year, it is munis that have been hit harder. The 10-year AAA muni benchmark yield has risen higher (+134 basis points) than the comparable Treasury (+112). Same for the 30-year, with the muni yield up 89 basis points versus the Treasury at +78.

Three Months of Losses are Enough

Muni ETFs and money market funds continue to rake in cash as investors like the liquidity, low fees, and attractive yields. Yet for most muni traders, September is a month we are glad to have behind us. High yield munis had been outperforming the fixed income sector all year and they are still beating Treasury and investment grade corporate returns. However, as with all tax-exempts, performance has been negative for the last three months. Investment grade and longer maturity bonds were hardest hit in the third quarter.

Keep Truckin’

As we begin the final quarter of the year, we expect at least one more Fed rate hike. The markets have already assumed this, but there is always some volatility when the announcement is made, and press conference held. There are also key economic data releases expected before the October 28 and December 9 Federal Open Market Committee meetings. So, there may be a few more upward moves in yields to come and it makes sense to keep some cash on the side. But why not go on the hunt for some muni gems now? Some investors are starting to gather or divert funds held elsewhere to deploy in long-term income investment opportunities with eye-popping tax-equivalent yields that rival some far riskier corporate and stock offerings. And many borrowers – all those with solid projects and savvy finance teams — are undeterred by the volatility and moving forward with very attractive investment opportunities. Some refunding plans may not work right now, but tax-exempt new money is still relatively cheap and, with a little flexibility on price or structure, non-profits and local governments can finally get long-awaited projects off the drawing board and finally put shovels into the ground.

Road Conditions

We know that road conditions across all market highways have been deteriorating for some time now – the stubborn inflation in consumer staples, the impact of the Iran War on gas and diesel prices aggravating agri-business, trucking, and Main Street sentiment, the debt, the deficit, the mid-term elections that may change the course or accelerate the pace of some administration policies. There are no crystal balls or easy solutions here. Yet many of these troubles have been overshadowed by the AI boom, the excitement over technology that is changing the world, the record high corporate issuance and massive IPOs, the huge backlog in municipal infrastructure financing that has spurred three straight years of record volume, the huge muni reinvestment demand and explosive growth of muni ETFs. We never know exactly where we are in the economic cycle or what the next disruption to the status quo will be. Will it be a welcome end to one war or two? A new war involving NATO? Another federal intervention with stimulus or some type of rate cap? A change in House and Senate control, an election mishap, a cyberattack, an AI agent gone haywire, a bank run? There could be any number of other developments or black swans for which no prediction markets yet exist.

Brakes and Gas Pedals

The third quarter began with a selloff that involved broader market concerns with oil prices and unsettling inflation trends, on/off Middle East negotiations, new developments with Ukraine and Russia, the Federal Reserve’s new chief asking markets to take the lead, conflicting economic data, and a host of domestic political and foreign policy concerns that weighed on Treasury auctions and sent yields higher. We begin a new quarter now with many of the same concerns. But portfolios have been rebalanced and exposures adjusted. Higher tax-exempt income is a great lure, a partial antidote to inflation, and in comes in a sector that is not directly impacted by the Iran war or global crises. The speed and extent of the yield spikes have certainly startled some borrowers. Several large, rate-sensitive deals are on a day-to-day status. But the great thing about the municipal market is that it moves forward. Deals are getting done in both the competitive and negotiated markets. A total of $520.7 billion has come to market during these past nine months. CreditSights reports that customers have been net buyers since August. Mutual funds have taken in a net of $30.4 billion this year, and ETFs have taken in $44.7 billion; combined, these assets now exceed $1.09 trillion.

Exit Ramps and Express Lanes

Muni investors cannot help but watch the rapid moves in Treasury yields, follow the weak auctions, and hear all the Fedspeak without feeling pressured. Since July, it has felt like a good time for investors to do some tax loss harvesting. That has led to some new trading records at the same time that heavy weekly issuance has caused broker-dealer inventory to swell, forced marketing teams to vie for attention, and vexed underwriters trying to price deals amid dramatic intraday moves. Investors have been unsured of what to do — sit on the sidelines until things calm down, sell low coupons, demand more concessions, or scrutinize offerings for unusually good credits and prices and buy, buy, buy.

Road Maps

At HJ Sims, we work with investors seeking guidance while also helping borrowers to understand and appreciate both the needs and concerns of major buyers as well as the whipsaws and vagaries of the market. New deals are coming with tighter covenants, better disclosure, and stronger security that they did 25 years ago. Tax-exemption is the biggest draw, but there will always be demand for creditworthy bonds to buy, hold, produce steady income and hedge against volatility in the equity and commodity markets. Today, higher yielding tax-exempt bonds provide one of the best buying opportunities in a generation. Reach out to your HJ Sims representative today and let us know the size of your truck.