Municipals were steady, underperforming U.S. Treasuries after the Federal Reserve held rates, as expected. Equities ended up.
Wednesday was about setting market participants up for a policy change in September, said Jeff MacDonald, executive vice president and head of fixed-income strategies at Fiduciary Trust International.
The muni yield curve has “remained stubbornly inverted” throughout most of 2023 and into 2024, said Sam Weitzman, a product manager at Western Asset Management.
“Shortest-term yields have been buoyed higher by the Fed hiking cycle, coupled with short-term muni demand as many investors shifted shorter allocations to money market funds and other cash equivalents yielding greater than 5%,” he said. “Meanwhile, intermediate maturities, particularly securities within five to 10 years, were anchored lower by expectations that the Fed would eventually cut interest rates but exacerbated by strong separately managed account investment.”
The front end of the muni yield curve has “materially disinverted” since the start of the second quarter, Weitzman said.
Fed actions will provide an opportunity for the yield curve to “uninvert” further, MacDonald added. The adjustment in Fed policy will create a “more normalized sloping yield curve,” he said.
“Rates are likely to move down in terms of longer maturities, but an aggressive move lower in longer maturity rates would need to be accompanied by enough economic weakness and potentially higher odds of a recession, though we don’t really see it,” MacDonald said.
Front-end rates will come down meaningfully as the Fed cuts rates and into 2025, he said.
That will put “downward pressure” on money markets, potentially pushing some investor dollars further out onto the curve, MacDonald said.
The two-year muni-to-Treasury ratio Tuesday was at 66%, the three-year at 67%, the five-year at 69%, the 10-year at 69% and the 30-year at 84%, according to Refinitiv Municipal Market Data’s 3 p.m. EST read. ICE Data Services had the two-year at 65%, the three-year at 66%, the five-year at 68%, the 10-year at 68% and the 30-year at 83% at 3:30 p.m.
The Investment Company Institute reported Wednesday $794 million of inflows into municipal bond mutual funds for the week ending July 24 following $818 million of inflows the week prior.
Exchange-traded funds saw inflows of $628 million, following inflows of $814 million the week prior.
AAA scales
Refinitiv MMD’s scale was unchanged: The one-year was at 2.86% and 2.85% in two years. The five-year was at 2.75%, the 10-year at 2.82% and the 30-year at 3.68% at 3 p.m.
The ICE AAA yield curve was bumped one to two basis points: 2.88% (-2) in 2025 and 2.83% (-1) in 2026. The five-year was at 2.75% (-1), the 10-year was at 2.79% (-2) and the 30-year was at 3.64% (-2) at 3:30 p.m.
The S&P Global Market Intelligence municipal curve was bumped up to two basis points: The one-year was at 2.88% (-1) in 2025 and 2.85% (-2) in 2026. The five-year was at 2.77% (unch), the 10-year was at 2.81% (unch) and the 30-year yield was at 3.64% (unch) at 3 p.m.
Bloomberg BVAL was little changed: 2.87% (unch) in 2025 and 2.83% (unch) in 2026. The five-year at 2.74% (unch), the 10-year at 2.76% (unch) and the 30-year at 3.65% (unch) at 3:30 p.m.
Treasuries were firmer.
The two-year UST was yielding 4.293% (-6), the three-year was at 4.104% (-7), the five-year at 3.964% (-7), the 10-year at 4.081% (-6), the 20-year at 4.435% (-6) and the 30-year at 4.351% (-5) at 3:30 p.m.
FOMC
The Federal Open Market Committee held the fed funds rate target at a range of 5.25% to 5.50% but offered no clear clue about a September rate cut.
While noting “some further progress” toward its inflation goal, risks to meeting its dual mandate “continue to move into better balance,” the statement said.
It termed inflation “somewhat elevated” and still needs “greater confidence” before cutting rates.
“The Fed decided [Wednesday] to not reduce interest rates and did not give a clear signal that a decrease would be coming in September,” said Morning Consult economist Sofia Baig. “Continuing to keep rates elevated could be harmful for consumers and the economy as a whole, which is already showing signs of cooling.”
Brian Coulton, Fitch Ratings chief economist, said, “The key is starting to turn slowly as the Fed prepares to unlock the door to a rate cut in September.”
He noted the Fed is keying in on its employment mandate. “This largely reflects greater confidence that progress on disinflation has resumed, after the setbacks in the first four months of the year,” he said.
With the Fed saying inflation is “somewhat elevated” instead of simply “elevated,” Coulton said, it “feels like it is sending a signal that they think the data will have evolved in such a way as to justify the first cut in September.”
“The statement changed but fell short of suggesting the Fed is contemplating a September rate cut,” said Chris Low, chief economist at FHN Financial. “In fact, looking at all the opportunities the Fed had to signal success against inflation and willingness to ease at an upcoming meeting, the FOMC opted for language bordering on excessive caution.”
FOMC voters “clearly want to see more low inflation readings in the July and August reports or significant employment weakness in July, August and/or September,” he said.
In his press conference, Fed Chair Jerome Powell said no decision has been made about September, which will be data dependent. But, he said, a rate cut “could be on the table as early as September.”
If inflation moved down quickly, with strong growth and employment at current levels, Powell again said a rate cut could be considered in September. He said the panel is close to having confidence inflation is on track toward the 2% target, “but we’re not there yet.”
When asked if the Fed could be behind the curve if it waits to cut in September, Powell said, “there’s no guarantees; it’s a difficult judgment call.” He said there was conversation at the meeting about cutting, with the majority in favor of holding rates.
Politics will not enter into any Fed decision, Powell said, which will be based on “the data, the outlook and the balance of risks.” When asked, he said the panel was “not thinking about” a 50 basis-point cut at the first reduction, but no decision has been made.
“The Fed’s current position reflects a reluctance to ease interest rates in the near term, instilling a sense of cautious optimism among investors,” said Paul Feinstein, CEO and founder of Audent Global Asset Management.
“The combination of second quarter disinflation progress, a softening labor market, and policymaker rhetoric all point toward a September start to the Fed’s cutting cycle,” said Kay Haigh, global co-head of fixed income and liquidity solutions within Goldman Sachs Asset Management. “The pace of easing will depend on resilience in the labor market, inflation dynamics, and fiscal policy post-election. For investors, the implication is clear: fixed income assets and curve steepener exposures are well-positioned to benefit from rate cuts against a backdrop of sound credit and economic fundamentals.”
“The Fed remains data dependent as always, but it now appears that the ‘more good data’ bar is not as high as it was before, particularly with labor market developments becoming more important,” said Michael Gregory, deputy chief economist at BMO Economics.
With two employment reports and consumer price index reports coming before the next FOMC meeting, “if the interim data continue their current themes (ebbing inflation pressures, weakening labor market outcomes),” BMO expects a September rate cut.
Primary to come
The Port of Seattle (A1/AA-/AA-/) is set to price Thursday $822.225 million of intermediate lien revenue refunding bonds, consisting of $170.825 million of non-AMT bonds, Series 2024A, serials 2025-2044, and $651.4 million of AMT bonds, Series 2024B, serials 2025-2044, term 2049. BofA Securities.
Tallahassee, Florida, (Aa3/AA//) is set to price Thursday $201.295 million of energy system refunding revenue bonds, Series 2024, serials 2025-2042. Raymond James.
The Fayette County Development Authority, Georgia, (//BBB/) is set to price Thursday
The Detroit Regional Convention Facility Authority (/A+/AA-/) is set to price Thursday $107.98 million of convention facility special tax revenue refunding bonds, Series 2024C. J.P. Morgan.
Competitive
Glendale, California, is set to sell $166.88 million of electric revenue bonds, 2024 Second Series, at 11 a.m. Eastern Thursday.
Gary Siegel contributed to this story.