Market Hindrances
In attempting to glean some truisms about where the municipal market is leading there are several potential hindrances that need to reach some resolutions or perhaps there will be none.
The Fed continues to be first and foremost with what the actions will be regarding future hikes. Consensus has built around the position there will be no action taken at the next meeting but there is more of a probability of an additional tightening in November. With the latest inflation reading at 3.7%, I would say that the Fed will continue to lean in the tightening direction even if we have a pause at the next meeting.
In the meantime, the curve continues to be inverted with the 2-year Treasury at 5.0% and the 30-year Treasury at 4.36% as of this writing. The inversion may not be quite as steep, but it remains present. Staying short has been a good strategy, but there is a lot more chatter about fixed income and the cautious need to extend maturities and duration. A lot of this posture assumes that the Fed is close to being done with its tightening campaign. We know that the data will be the deciding factor. Nevertheless, most observers do not see any easing on the horizon until next year around the second quarter timeframe.
Supply continues to be down in the municipal market. Most issuers are not keen on paying higher rates. But the rate pressure will continue to build over time before any course correction takes place. We used to have an environment where any worries were subdued in issuing in a higher rate scenario by the prospect of doing an advance refunding in the future. As we know that option is gone. Some participants are still lobbying to bring back advance refunding but given federal budget realities any change is a long shot.
Focusing on the federal budget over the next few weeks is of paramount importance. It is very hard to say just how much of a drag the impeachment process will have on the ability to formulate a budget proposal that will be bipartisan in nature. We know that there is a concerted effort to find and to champion cuts on the spending side. The parties are far apart on this matter. Although the debt ceiling consideration is postponed until 2025, there still will be a vigorous discussion about the future course for the federal debt. Quite a few articles of late have focused on the fact that the interest carry on the budget is now rivalling defense spending.
The heightened issuance of Treasury bonds has been orderly to date. However, the tone in the market could change rapidly especially if the foreign buying attenuates for a myriad of reasons. Perhaps, municipal ratios to the equivalent Treasury bond will become more distorted.
One tendency I have witnessed of late in the municipal market is to dismiss these and other critical factors as not having a bearing on the municipal market tone and performance. This posture was often the case forty or fifty years ago when the market was not as large and non-traditional buyers were nowhere to be found. We need to continue to heed all these inputs.
If the federal budget deliberations go badly even assuming a continuation budget, the rating for the USA may remain a consideration. I do not anticipate any sharp actions at this time but the language adopted in rating reports should be an indicator of future direction.
The economy continues to perform well under the circumstances. Recession is not imminent. Job openings have moderated somewhat and incomes are not keeping up with inflation but no serious changes appear to be underway. The soft-landing scenario is gaining traction.
While these macro events continue to unfold, the municipal market continues to be focused on transparency, accounting, budgeting, and debt issuance trends.
John Hallacy
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