Investors tonight find themselves in a precarious position as they navigate a municipal market that is beginning to show signs of firmness. This rebound is set against a backdrop of heightened volatility that is expected due to the dual uncertainties posed by the upcoming U.S. elections and the critical decisions awaiting the Federal Open Market Committee (FOMC) regarding interest rates. As market participants strategically position themselves, US Treasury yields displayed a decline, particularly notable among longer-term bonds, while equities reflected a downturn as the day progressed.
Municipal Ratios Signaling Market Sentiment
Recent data from Refinitiv Municipal Market Data illustrates a decrease in municipal-to-U.S. Treasury ratios, with the two-year ratio positioned at 63% and the 30-year at a relatively higher 85%. These figures underscore a sentiment of cautious optimism among investors, who are apprehensive about how the election results may alter the political and economic scenery. Daryl Clements, a municipal portfolio manager with AllianceBernstein, warns that sharp reactions may follow the elections. He indicated that significant changes in yields and inflation expectations are anticipated, regardless of the winning side of the political spectrum.
Tom Kozlik, from HilltopSecurities, echoes similar sentiments, urging investors to remain alert as outcomes may yield unstable economic forecasts. A shift towards a divided government may prove beneficial, aiding in diminishing both yields and inflation expectations, as neither party will be able to impose radical changes without the other’s consent. Nevertheless, Clements believes that ultimately, yields should trend lower over time.
Attention now centers on the impending FOMC meeting, which holds the potential for pivotal shifts in monetary policy. The initial projections had anticipated a rate cut following the recent 50-basis-point reduction; however, a cautious approach may just as easily be taken. Economic data released last week painted a less favorable picture than what forecasts had suggested, suggesting that the labor market remains weaker than hoped. With third-quarter GDP growth slightly below expectations and alarming employment numbers, the Fed’s decision-making process remains tethered to forthcoming data.
Investor behavior has reflected growing caution due to the political landscape while concurrently signaling a rare opportunity with attractive yield levels in municipal markets. Birch Creek’s strategists note that as the election draws near, liquidity has been thinning, prompting sellers to adopt more realistic pricing strategies compared to earlier weeks. This adjustment comes amid a 34% increase in bid solicitations, particularly for bonds over 10 years, indicating that buyers are finding value in the current yield environment.
Confidence in the municipal market appears robust as evidenced by LSEG Lipper’s report of continued positive inflows into municipal mutual funds, totaling $659 million last week. This marks the 18th consecutive week of inflows, confirming a strong demand for municipals amidst prevailing uncertainty. Clements notes that the technical dynamics of the market are becoming more favorable, especially with anticipated declines in new issue supply—which is projected to reach negative $23 billion by the end of the year.
As market participants await election outcomes, Pat Luby from CreditSights highlights a distinct lull in new issuance activity, indicating a quiet week ahead. Despite the expected reduction in supply, noteworthy deals continue to enter the market, reaffirming ongoing activity.
Municipal yields have recently experienced a rise of 32 basis points, now averaging 3.66%. This uptick highlights a critical juncture for investors considering the longer-term perspective for yields over the next year. The AAA-rated municipal scales across various indices also reflect similar upward adjustments, signaling the potential for increased returns as the market recalibrates.
In addition to yield adjustments, the solid performance in U.S. Treasury bonds supports market navigation through uncertainty. Recent treasuries showed a notable drop in yield across multiple tenors, suggestive of a more favorable risk-off sentiment. As strategic investment decisions are made, the balance between municipal performance and treasury movements is expected to remain closely intertwined.
The confluence of political uncertainty and monetary policy considerations suggests that the coming weeks will be pivotal for both municipal and treasury markets. Investors must remain adaptive, with a careful evaluation of market signals to seize potential opportunities. As both domestic and global economic landscapes continue to evolve, strategizing for upcoming volatility will be essential in maximizing the benefits of an increasingly dynamic market environment.