Renewed Focus
There have been times last year when municipals were hardly mentioned in the financial press. The action in equities overwhelmed commentary about other asset classes at that time. There has been a sharp change.
Now municipals and all of fixed income are being discussed considerably more often. Pundits have talked about municipals from the standpoint of their special status as tax exempt and now that the yields are more attractive once again.
But the characteristic most often mentioned about municipals is their stability. Credit quality has endured despite many factors that have turned negative. Clearly, we are not talking about the high yield segment of the market. Despite some volatility this year, returns in municipals are positive.
Supply is starting to do its seasonal climb. We will be testing the demand and the liquidity more. Issuers are considering their issue sizes carefully given there remain some ongoing questions about demand. The inflow and outflow proportions continue to fluctuate in both the positive and negative directions. A real test of the market will be in the higher supply environment.
We have some time before the next Fed meeting and some of the recent data has not cooperated in the goal of subduing inflation. On the other hand, we are hearing about more layoffs especially in the tech sector but the trend has widened to other industries.
Housing sales have improved with some moderation in mortgage rates. Retail sales have been stronger than most reasonable expectations would have indicated.
The bottom line is the economy continues to perform reasonably well and consumers are doing what they do best. They are continuing to spend.
The Treasury curve is flat from 10 years to 30 years at 3.9%. All the inversion is the sharpest on the shorter end. The 3 months rate is at 4.69% vs. the 10 year rate at 3.90%. This informs us that municipal issuers still may obtain a great rate in the market by putting supply on the long maturities. Retail buyers will keep doing better by staying ten years and shorter. Until supply increases to the point where rates reflect a weakening appetite, this may be one of the best times to get to market for issuers this year.
Most pundits support the view that the Fed will keep tightening until there is more evidence that the economy is slowing and inflation is on the wane. However, we have heard some talk lately of a “no landing” scenario. Such a scenario would require a lot more Fed action on rates.
Municipal credit has some interesting challenges ahead. The disaster in East Palestine requires some probing analysis. Responsibility needs to be carefully considered and the mitigation must continue swiftly. Who ultimately pays will take time to sort out. One aspect is fairly certain that the community is not in the position to do much on its own and requires a great deal of support from other entities.
ESG continues to be a flashpoint in some jurisdictions. It appears that if satisfactory credentials may not be approved and obtained easily by the sell side, competitive bid is the necessary approach. Competitive bid has worked especially well for plain vanilla credits over the years. Although this premise remains true, more credits have been coming to market on a negotiated basis. It is hard to see how a highly structured transactions may tap the competitive market. It has been done before but is not always the optimal solution. Buyers prefer to have good selection and the ability to maintain preferences when it comes to maturities and coupons. There is no flexibility in this regard in the competitive market.
Supply in February has continued its downward trend coming in on a preliminary basis at approximately $17.8 billion versus $31.6 billion last year. The good news is that CA and WI sharply increased issuance in the month. Other states that increased issuance in the month include GA, TX, and KS.
It is refreshing to see that municipals are garnering some well deserved attention. There has been a lot of touting about buying short Treasury bonds in this environment. Now that municipals are being cited in the same vein, municipal securities are rightfully being given similar treatment.
John Hallacy
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