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 just about met expectations, but showed inflation stays sticky, shouldn’t deter the Federal Open Market Committee by cutting 25 basis points next week, analysts said.
“CPI inflation for November was uncomfortably warm regardless that 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% within the month, same as each of the past 4 months, he said, “though this was also in-line with our and the consensus expectation.” The three-month average core rate stays a “hot 3.7% annualized, well above the Fed’s 2.0% goal,” Anderson noted.
Still the numbers “likely won’t preclude the Federal Reserve from another quarter-point rate cut before the top of the 12 months.”
UST yields rose following the print, with the most important losses out long, and muni yields followed with a weaker tone and small cuts, depending on the size.
Municipal investors are more focused on the ultimate new-issues coming down the pike and repositioning books as 2024 heads to a detailed. The asset class is outperforming USTs and corporates as of Wednesday, with the Bloomberg Municipal Index returning +0.23% this month in comparison with -0.02% for USTs and +0.16% for corporate bonds.
This 12 months has been inundated with supply, but investors have “definitely met the duty,” particularly demand from individually managed accounts and a rebound from muni mutual funds, said John Flahive, head of fixed income at BNY Wealth.
Fund flows were once more 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 significantly better shape than the huge outflows of previous two years, Flahive said.
“So it’s good to see some stabilization on that front,” he said.
Ratios will not be as low cost as “possibly we would love them,” and Flahive added he doesn’t imagine they may cheapen materially within the near term.
The 2-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%, in keeping with 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 top 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 probably be much like this 12 months, because the market experiences one other volatile 12 months with rates of interest, the uncertainty surrounding the brand new administration and its policies, in addition to Central Bank policymaking, he said.
With yields where they’re today, the “ballast role” of fixed income is in place, he said.
If equities dump or the economy experiences an slowdown, rates may go lower, Flahive said.
“Despite broad macro uncertainty with respect to monetary policy and financial policy under a latest administration, we anticipate municipals having a positive 12 months in 2025, with periods of heightened volatility,” said James Welch, a municipal portfolio manager at Principal Asset Management.
“Expectations are for total returns within the +5% range, with longer-dated and lower-rated securities outperforming,” he said.
Positive returns will probably be fueled by absolute yields at or near multi-decade highs, the gradual compression of credit spreads, regular/increasing demand into the mutual fund complex and the continued rise of SMAs and exchange-traded funds, together with taxable equivalent yields within the 8%-10% range, Welch said.
Bond volume and the controversy over the extension of the Tax Cuts and Jobs Act will probably be on the forefront in 2025, he said.
Supply is anticipated to surpass $500 billion, a latest record, as a consequence of increased infrastructure needs and the top of fiscal aid from Washington, Welch said.
Meanwhile, for the TCJA provisions to be prolonged, revenue offsets will probably be needed, he said.
“Though the elimination of the tax exemption will probably be one option sure to be debated, we see NO likelihood of that taking place and any hostile market response (i.e., higher yields) based around such discuss with be a possibility so as to add municipal exposure,” Welch said.
In the first market Wednesday, Goldman Sachs priced for the California Community Selection 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 might want to see more improvement on the inflation front within the months ahead, if its plan for a gentle pace of additional rate cuts next 12 months is to be fulfilled,” he said, adding that giant import tariffs initially of next 12 months “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 just a few headlines noting progress toward 2% inflation has stalled. For what it’s price, 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 stays above the Fed’s goal, it’s “not hot enough for us to vary our call for a 25bp rate cut on 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 for the reason that inflation scare of early 2024, price pressures are hardly settling at a level that the Fed might be completely comfy with.”
Still, Shah noted, “there may be some excellent news here — owner equivalent rent has fallen to the slowest pace since January 2021. But overall, the Fed will probably be concerned by the very stubborn nature of inflation and will probably be increasingly cautious in regards to the upside inflation risks that President-elect Trump’s policies may bring.”
Because of this, the Fed will take “a more cautious tone,” in the brand new 12 months, with cuts coming every other meeting, Shah said.
Despite meeting expectations, the report “will cause some handwringing on the Fed,” said Fitch Rankings Chief Economist Brian Coulton. “Core inflation momentum — the three-month-on-three-month annualized rate — has risen again to three.4% and is now running above the year-on-year rate (of three.3%).” The decline in core goods prices — which was an enormous a part of the general disinflation story this 12 months — looks to be over, with core goods prices rising 0.3% month-on-month as automotive prices jumped. Services inflation is coming down but only very slowly — as rental inflation proves stubborn — and, at 4.6%, stays far higher than pre-pandemic rates.”
While the three.3% annualized core “continues to be uncomfortably high for the central bank, but given how restrictive policy has been this 12 months, there may be 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.
Moreover, the brand new presidential administration and President-elect Trump’s proposed tariff and tax plans could increase price pressures, she said, “meaning the Fed will probably be limited next 12 months almost about how much it may lower rates. For this reason, a cut in December looks like a legitimate move because it brings the speed closer to normalization before the tide may turn next 12 months.”
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 better inflation goal or it would must pause after next week’s meeting. The latter is more likely, especially because the labor market continues to be robust and doesn’t need the Fed’s immediate attention.”
Still, Morgan Stanley economists said, “In our view, this can be a favorable report for the Fed.”
Recent inflation reads showed “some residual firmness that has cause some alarm throughout the committee.” But, they said, “the softer-than-expected increase in rents and [owners’ equivalent rent] inflation” provides “a signal that inflation stays in a downward trend.”
Besides a cut next week, Morgan Stanley expects the Fed “to ease 25bp at consecutive FOMC meetings, including in January, versus shifting to a more gradual quarterly pace of cuts.”
Primary to return:
The Public Finance Authority is ready to cost $172.595 million of nonrated Inperium Project revenue refunding bonds, terms 2034, 2044, 2049. KeyBanc Capital Markets.
The Iowa Finance Authority (//BBB/) is ready to cost 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 Latest York State Housing Finance Agency (Aa1///) is ready to cost 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 ready 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, Latest York, is ready to sell $350 million of tax anticipation notes at 11 a.m. Thursday.
Gary Siegel contributed to this story.