Municipal Bonds Experience Losses Amid U.S. Treasury Selloff
Municipal bonds faced losses but outperformed a U.S. Treasury selloff triggered by stronger-than-expected jobs data, as investors prepare for the June Federal Open Market Committee meeting with a smaller primary slate.
The non-farm payrolls data has raised concerns about the timing of the Central Bank’s rate-cutting schedule. “This blockbuster NFP makes it harder for the Fed to consider a rate cut,” said Giuseppe Sette, president of Toggle AI. “The next few months will be critical as the Fed navigates the robust performance of the U.S. economy, limiting its ability to follow the example of the European Central Bank and cut rates.”
Following the release of the data, U.S. Treasuries saw a spike in yields, with triple-A curves experiencing a more subdued reaction. Despite a strong performance throughout the week, both munis and USTs saw yields rise, with municipal bonds absorbing a substantial new-issue slate of over $15 billion.
Municipal bond mutual funds saw a return to inflows, particularly in long-term funds, while high-yield funds continued to perform positively. The Bloomberg Municipal Index showed positive returns, with the High-Yield Index also posting gains.
In comparison to other asset classes, municipal bonds showed favorable returns, with ratios against USTs falling as Treasury levels rose. The upcoming week’s new-issue calendar is expected to be lighter, with notable offerings from Los Angeles County, the Massachusetts Water Resources Authority, and the New York City Housing Development Authority.
Despite the recent rally in the muni market, analysts caution that Treasury volatility may return, and supply is expected to remain high. Investors are advised not to chase the rally and consider lightening their positions to wait for a better entry point in the future.
AAA scales for municipal bonds were adjusted downwards, while Treasuries experienced a selloff across the board. The strong jobs data has tempered expectations for a Fed rate cut, indicating continued strength in labor demand. Coulton and Wren, experts in the field of labor market analysis, expressed concerns over the recent news on labor supply and demand. They noted that the Federal Reserve (Fed) may not be pleased with the current state of the labor market, as it does not align with their expectations of easing labor market imbalances.
According to Wren, the unexpectedly strong payrolls in May were not in line with what the Federal Open Market Committee (FOMC) desires. He mentioned that the FOMC prefers to see weaker employment and wage data. As a result, Wren believes that rate cuts are currently on hold, with Wells Fargo anticipating two cuts in 2024.
Wren also advised caution when it comes to equity and fixed income exposure, suggesting that investors should wait for better entry points in these asset classes. He emphasized the importance of buying equities at lower valuations and extending duration by purchasing long-term Treasuries at higher yields.
John Kerschner, from Janus Henderson Investors, shared a similar sentiment, stating that the Fed may want to cut rates later this year, possibly in September. He mentioned that when rate cuts do occur, they may not lead to a consistent hiking cycle, but rather a more sporadic pattern.
Kerschner also pointed out that an easing cycle will take time to normalize the yield curve, which is currently deeply inverted. He believes that it may take quarters, if not years, for the yield curve to rectify itself.
In the municipal bond market, various entities are set to price bonds on Tuesday, including Los Angeles County, the Massachusetts Water Resources Authority, and the New York City Housing Development. These bonds will fund projects ranging from school facilities to sustainable development initiatives.
Overall, experts are keeping a close eye on the labor market and the implications of potential rate cuts by the Fed. They advise investors to proceed with caution and look for opportunities in both equity and fixed income markets.