Municipals were a touch weaker in spots Wednesday, as U.S. Treasury yields rose and equities ended mixed after an inflation print aligned with expectations.
A consumer price index that pretty much met expectations, but showed inflation remains sticky, should not deter the Federal Open Market Committee by cutting 25 basis points next week, analysts said.
“CPI inflation for November was uncomfortably warm even though it was in-line with the consensus forecast,” noted Scott Anderson, chief U.S. economist and managing director at BMO Economics.
Core CPI, which excludes food and energy, rose 0.3% in the month, same as each of the past four months, he said, “though this was also in-line with our and the consensus expectation.” The three-month average core rate remains a “hot 3.7% annualized, well above the Fed’s 2.0% target,” Anderson noted.
Still the numbers “likely won’t preclude the Federal Reserve from one more quarter-point rate cut before the end of the year.”
UST yields rose following the print, with the largest losses out long, and muni yields followed with a weaker tone and small cuts, depending on the scale.
Municipal investors are more focused on the final new-issues coming down the pike and repositioning books as 2024 heads to a close. The asset class is outperforming USTs and corporates as of Wednesday, with the Bloomberg Municipal Index returning +0.23% this month compared to -0.02% for USTs and +0.16% for corporate bonds.
This year has been inundated with supply, but investors have “certainly met the task,” particularly demand from separately managed accounts and a rebound from muni mutual funds, said John Flahive, head of fixed income at BNY Mellon.
Fund flows were once again in positive territory with the Investment Company Institute reporting Wednesday that $520 million flowed into municipal bond mutual funds for the week ending Dec. 4, following $625 million of inflows the previous week. This marks 17 consecutive weeks of inflows, per ICI data.
Exchange-traded funds saw inflows of $478 million after $966 million of inflows the week prior.
With the recent spate of inflows, mutual funds are in much better shape than the massive outflows of previous two years, Flahive said.
“So it’s good to see some stabilization on that front,” he said.
Ratios are not as cheap as “maybe we would like them,” and Flahive added he does not believe they will cheapen materially in the near term.
The two-year municipal to UST ratio Wednesday was at 61%, the five-year at 62%, the 10-year at 65% and the 30-year at 80%, according to Municipal Market Data’s 3 p.m. EST read. ICE Data Services had the two-year at 61%, the five-year at 62%, the 10-year at 65% and the 30-year at 80% at 3:30 p.m.
Through the end of November, muni-UST ratios inside 10 years moved eight percentage points higher, a “pretty big move,” Flahive said, as ratios went from the high 50s to mid-60s.
Fixed income in 2025 will be similar to this year, as the market experiences another volatile year with interest rates, the uncertainty surrounding the new administration and its policies, as well as Central Bank policymaking, he said.
With yields where they are today, the “ballast role” of fixed income is in place, he said.
If equities sell off or the economy experiences an slowdown, rates may go lower, Flahive said.
“Despite broad macro uncertainty with respect to monetary policy and fiscal policy under a new administration, we anticipate municipals having a positive year in 2025, with periods of heightened volatility,” said James Welch, a municipal portfolio manager at Principal Asset Management.
“Expectations are for total returns in the +5% range, with longer-dated and lower-rated securities outperforming,” he said.
Positive returns will be fueled by absolute yields at or near multi-decade highs, the gradual compression of credit spreads, steady/increasing demand into the mutual fund complex and the continued rise of SMAs and exchange-traded funds, along with taxable equivalent yields in the 8%-10% range, Welch said.
Bond volume and the debate over the extension of the Tax Cuts and Jobs Act will be at the forefront in 2025, he said.
Supply is expected to surpass $500 billion, a new record, due to increased infrastructure needs and the end of fiscal aid from Washington, Welch said.
Meanwhile, for the TCJA provisions to be extended, revenue offsets will be needed, he said.
“Though the elimination of the tax exemption will be one option sure to be debated, we see NO chance of that happening and any adverse market reaction (i.e., higher yields) based around such talk to be an opportunity to add municipal exposure,” Welch said.
In the primary market Wednesday, Goldman Sachs priced for the California Community Choice Financing Authority (Aaa///) $1.298 billion of green clean energy project revenue bonds, Series 2024H, with 5s of 8/2031 at 3.42% and 5s of 2033 at 3.58%, make whole call.
CPI ‘favorable’ enough for the Fed’s next rate cut
The CPI report had some positives: “improvement in services and housing inflation,” Anderson said.
Still, “the Fed will need to see more improvement on the inflation front in the months ahead, if its plan for a steady pace of additional rate cuts next year is to be fulfilled,” he said, adding that large import tariffs at the beginning of next year “could further aggravate the Fed’s lingering inflation problem.”
While the report hit expectations, Chris Low, chief economist at FHN Financial, said, the numbers were “high enough to prompt a few headlines noting progress toward 2% inflation has stalled. For what it’s worth, we noticed the stalled progress several months ago, as core inflation, year-on-year, has moved sideways since May.”
And while the report indicates inflation remains above the Fed’s target, it is “not hot enough for us to change our call for a 25bp rate cut at the December FOMC meeting.”
While the December cut is a given, Seema Shah, chief global strategist at Principal Asset Management, said, “with monthly core inflation hitting its strongest rate since the inflation scare of early 2024, price pressures are hardly settling at a level that the Fed can be completely at ease with.”
Still, Shah noted, “there is some good news here — owner equivalent rent has fallen to the slowest pace since January 2021. But overall, the Fed will be concerned by the very stubborn nature of inflation and will be increasingly cautious about the upside inflation risks that President-elect Trump’s policies may bring.”
As a result, the Fed will take “a more cautious tone,” in the new year, with cuts coming every other meeting, Shah said.
Despite meeting expectations, the report “will cause some handwringing at the Fed,” said Fitch Ratings Chief Economist Brian Coulton. “Core inflation momentum — the three-month-on-three-month annualized rate — has risen again to 3.4% and is now running above the year-on-year rate (of 3.3%).” The decline in core goods prices — which was a big part of the overall disinflation story this year — looks to be over, with core goods prices rising 0.3% month-on-month as car prices jumped. Services inflation is coming down but only very slowly — as rental inflation proves stubborn — and, at 4.6%, remains far higher than pre-pandemic rates.”
While the 3.3% annualized core “is still uncomfortably high for the central bank, but given how restrictive policy has been this year, there is wiggle room for the Fed to lower rates this month without triggering an uptick in inflation,” said Daniela Sabin Hathorn, senior market analyst at Capital.com.
Additionally, the new presidential administration and President-elect Trump’s proposed tariff and tax plans could increase price pressures, she said, “meaning the Fed will be limited next year with regards to how much it can lower rates. Because of this, a cut in December seems like a valid move as it brings the rate closer to normalization before the tide may turn next year.”
With the numbers indicating “progress towards lower inflation is stalling,” Jochen Stanzl, chief market analyst at CMC Markets, said, “either the Fed will accept a higher inflation target or it will have to pause after next week’s meeting. The latter is more likely, especially as the labor market is still robust and doesn’t need the Fed’s immediate attention.”
Still, Morgan Stanley economists said, “In our view, this is a favorable report for the Fed.”
Recent inflation reads showed “some residual firmness that has cause some alarm within the committee.” But, they said, “the softer-than-expected increase in rents and [owners’ equivalent rent] inflation” provides “a signal that inflation remains in a downward trend.”
Besides a cut next week, Morgan Stanley expects the Fed “to ease 25bp at consecutive FOMC meetings, including in January, as opposed to shifting to a more gradual quarterly pace of cuts.”
Primary to come:
The Public Finance Authority is set to price $172.595 million of nonrated Inperium Project revenue refunding bonds, terms 2034, 2044, 2049. KeyBanc Capital Markets.
The Iowa Finance Authority (//BBB/) is set to price Thursday $148.56 million of Lifespace Communities, Inc. revenue bonds, consisting of $128.905 million of Series 2024A and $19.995 million of Series 2024B. HJ Sims.
The New York State Housing Finance Agency (Aa1///) is set to price Thursday $124.275 million of economic development and housing sustainability state personal income tax revenue bonds, consisting of $9.6 million of Series B1, serials 2027-2036, terms 2039, 2044, 2049, 2054; $90.465 million of Series B2, serial 2054; and $24.66 million of Series C, serials 2028-2036, terms 2039, 2044, 2049, 2054. Siebert Williams Shank.
Competitive:
Massachusetts (Aa1/AA+/AA+/) is set to sell $800 million of GO consolidated loan of 2024 bonds in three series: $210 million of Series G at 10 a.m. eastern Thursday, $315 million of Series H at 10:30 a.m. Thursday and $275 million of Series I at 10 a.m. Thursday.
Suffolk County, New York, is set to sell $350 million of tax anticipation notes at 11 a.m. Thursday.
Gary Siegel contributed to this story.