Municipals had a stronger tone Tuesday as investors closed their books ahead of the Latest 12 months holiday while U.S. Treasuries were mixed and equities saw losses for the ultimate session of 2024.
While municipals have outperformed USTs on the entire in 2024, they’ll close December with losses. How taxables perform in early 2025 coupled with macroeconomic and policy uncertainty have municipal market participants on edge for what lies ahead.
Triple-A muni yields were little modified to stronger by one to 4 basis points in spots Tuesday, depending on the curve, while USTs saw small improvements on the front end and small losses 10-years and out. The ten-year UST closed at 4.571% while the 10-year muni sat at a spread of three.05%-3.11% per triple-A scales.
“The continuing concern that inflation has not been relegated to the rear-view mirror stays an underlying theme for the market,” said Chris Brigati, chief investment officer at SWBC.
The sharp upward move in 10-year UST yields because the Federal Reserve announced its initial rate cut in September indicates “the bond market has clearly had a distinct tackle the inflation picture, and participants are voting with their portfolios,” he said.
While the market didn’t “reclaim the April high of 4.73%,” Brigati said “technical and fundamental aspects suggest that not only will rates eventually test this support, but my expectation is that we are going to see a 5% yield handle sometime in the primary quarter of 2025.”
Municipals have outperformed USTs in December and on the entire of 2024, but still will close out 2024 with municipal prices and yields “at roughly their worst of the yr, leaving capital gain-only measures and lots of mutual fund/exchange-traded fund NAVs showing negative year-to-date returns,” noted Matt Fabian, partner at Municipal Market Analytics, Inc. “Most AAA muni yields are ending 2024 about 50-75 basis points higher and fund NAVs are negative; losses will hurt some asset raising efforts but higher yields will help individually managed account-style income strategies in 2025.”
The losses won’t help gather assets “for total return managers next yr, nevertheless it’s a superb thing for income sellers ahead of 2025’s risks,” he said.
The investment-grade Bloomberg Municipal Index was within the red at -1.59% in December as of Tuesday, posting returns of 0.91% for 2024. Bloomberg’s high-yield index was faring worse at -1.77% for the month but seeing 6.21% of returns for 2024. Taxable munis were -2.29% in December and +1.74% in 2024 while short index munis were within the black at 0.18% this month and seeing returns of three.09% in 2024.
Corporates were seeing losses of 1.74% in December with positive returns of two.32% in 2024 while USTs were seeing losses of 1.46% in December with just +0.66% returns this yr.
Ratios close the yr at still-rich levels in comparison with historicals, but barely higher on the short end in comparison with where they began it. The 2-year municipal to UST ratio Tuesday was at 66%, the five-year at 65%, the 10-year at 67% and the 30-year at 81%, in keeping with Municipal Market Data’s 1 p.m. EST read. ICE Data Services had the two-year at 66%, the five-year at 65%, the 10-year at 67% and the 30-year at 80% at 4 p.m.
They opened this yr with the two-year at 56%, the three-year at 57%, the five-year at 57%, the 10-year at 58% and the 30-year at 84%, in keeping with MMD.
“Municipal ratios as a percentage of Treasuries remain dearer from a historical perspective, but absolute yields proceed to entice investors with attractive levels,” Brigati said.
Fabian said expectations of a robust new-issue borrowing yr, led off by a really strong first quarter, “mean underwriters will need every basis point of yield and spread they’ll get.”
“Note that, despite only a mean December issuance total of ~$35B, which is the smallest total because the summer, the month already has 1.34M trades within the books: highest variety of the yr and highlighting the sturdiness and strength of SMA demand for product, especially with more income now available,” Fabian said.
“So where normally a reliance on one investor type is a weakness — especially seeing the recent reversal of fund inflows and the accelerating runoff from banks — the bid from SMAs has been strong enough (as long as yields are high enough),” he said.
Fabian noted there was a “seemingly accelerating bank exit from municipals” because the election, which “suggests wider spreads for smaller safe-sector borrowers (and a related opportunity for retail buyers) in 2025.”
Indeed, Bank ownership of munis fell to $497.2 billion, down 0.3% from the second quarter of this yr and a decrease of 4.3% from third quarter 2023 while brokers and dealer muni holdings fell essentially the most quarter-over-quarter, declining by 10.5% to $16.2 billion, in keeping with the newest Federal Reserve data from early December.
“The growing catalog of state borrowers forecasting budget issues (CO, IL, MD, ME, NJ, NY, RI, WA and the remainder), not to say cities doing the identical, imply softer/worse rating trajectories and thus a standing need for institutional investing as well,” Fabian said.
The muni market saw a record $507.585 billion of debt issued in 2024, up 31.8% from $385.061 billion in 2023, in keeping with LSEG data. Fabian said the potential for an additional yr of record issuance “is realistic, especially if Construct America Bond issuers, concerned in regards to the fate of 2026 subsidies and rising tax-exempt yields, speed up tender activity.”
Climate and severe-weather-related concerns might also drive more issuance as state and native governments need to handle rebuilding older infrastructure on top of the deficits that exist already.
“After which there’s Washington, D.C.,” Fabian said, noting the “rapidly worsening federal budget challenges imply each excess UST issuance and threats to U.S. credit rankings.”
The U.S. borrowing cap resumes on midnight Wednesday, bringing with it the chance of a protracted political impasse that invites market dislocation, downgrades and other headwinds for municipal bond issuers and investors.
The knock-on effects to municipal credits could also be smaller however the implications of upper UST yields most actually will drag munis along for the ride.
“The trajectory of UST yields is assumed to be higher, especially if trade wars or other aspects restart inflation fears,” he said.
This just isn’t to say the potential for threats to the tax exemption that many within the industry expect to be on the negotiating table.
Republicans take full control of the Congress on Friday. They’ll must either pass the debt ceiling provision as a part of a budget reconciliation bill or secure Democrats’ support for passage of a separate bill.
AAA scales
MMD’s scale was unchanged: The one-year was at 2.86% and a couple of.82% in two years. The five-year was at 2.87%, the 10-year at 3.06% and the 30-year at 3.90% at 1 p.m.
The ICE AAA yield curve was bumped up to at least one basis point: 2.90% (-1) in 2025 and a couple of.83% (-1) in 2026. The five-year was at 2.84% (-1), the 10-year was at 3.05% (-1) and the 30-year was at 3.83% (-1) at 2 p.m.
The S&P Global Market Intelligence municipal curve was bumped one to 2 basis points: The one-year was at 2.87% in 2025 and a couple of.80% in 2026. The five-year was at 2.86%, the 10-year was at 3.06% and the 30-year yield was at 3.85% at 2 p.m.
Bloomberg BVAL was bumped one to 4 basis points: 2.95% (-1) in 2025 and a couple of.80% (-2) in 2026. The five-year at 2.85% (-4), the 10-year at 3.11% (-2) and the 30-year at 3.82% (-2) at 2 p.m.
Treasuries were mixed.
The 2-year UST was yielding 4.24% (-1), the three-year was at 4.271% (-1), the five-year at 4.382% (+1), the 10-year at 4.571% (+3), the 20-year at 4.862% (+2) and the 30-year at 4.787% (+2) at 2 p.m.