Municipals lost more ground Wednesday, but outperformed a selloff in the U.S. Treasury market, after the Federal Open Market Committee signaled fewer rate cuts on the horizon, with a likely pause in January. Equities also sold off, with the Dow Jones Industrial Average hitting a 10-day losing streak, the longest since the 1970s.
As expected, the FOMC lowered the fed funds 25 basis points to a range between 4.25% and 4.50%, while the Summary of Economic Projections reduced the expected number of cuts to two in 2025 from the previous estimate of four.
The SEP changes, with fewer rate cuts expected, pushed up bond yields, said Chris Low, chief economist at FHN Financial, noting “the biggest increase in two- and three-year notes and smaller increases in longer maturities, reflecting the expected pause, then resumed easing evident in the dot plot.”
Triple-A muni yields rose two to three basis points while Treasury yields rose up to 15 basis points after the FOMC news. The UST 10-year topped 4.5%.
Ratios rose slightly on the day’s moves. The two-year municipal to UST ratio Wednesday was at 61%, the five-year at 63%, the 10-year at 66% and the 30-year at 82%, according to Municipal Market Data’s 3 p.m. EST read. ICE Data Services had the two-year at 64%, the five-year at 65%, the 10-year at 68% and the 30-year at 82% at 4 p.m.
Jochen Stanzl, chief market analyst at CMC Markets had two takeaways from the FOMC statement. “The Fed is no longer just considering lower interest rates, but the timing and extent of future rate hikes,” plus there was a dissenting vote from Federal Reserve Bank of Cleveland President Beth M. Hammack, who preferred to keep rates where they were. “What we are seeing is clearly a signal that the Fed is almost done cutting rates.”
Stanzl expects “a major pause,” with the Fed being “much more conservative going forward, as short-term yields are at risk of rising again. Ten-year yields could rise to 5% or even 6% if markets begin pricing in higher growth and increased inflation for 2025. The Trump blessing could quickly turn into a curse. If market yields rise again, the Fed is unlikely to push back against these forces.”
As the market prepares for 2025, there’s a lot of uncertainty around what the new administration will mean for the macroeconomic environment and interest rates, the latter of which may be impacted by policy around the deficit, said Steve Shutz, portfolio manager and director of tax-exempt fixed income at Brown Advisory.
The Trump administration may also potentially double down on tariffs, with market participants wondering, “What does that ‘America First’ sort of policy do for the deficit and then potential inflation second-order effects,” he said.
For the muni market, the topic du jour is the tax policy, such as whether the 2017 Tax Cuts and Jobs Act will be extended, which Shutz expects to happen.
However, there’s the potential addition of provisions that could get “layered on” even beyond that, he said.
“There’s even talk of the threat of the tax exemption,”
“The noise around uncertainty with things like that could drive some demand volatility for the asset class,” Shutz said.
Supply has been the big story this year as issuance approaches $500 billion, above record levels of 2020 and 2021, Shutz said.
Last week was the final week of large new-issue numbers as supply slowed this week due to the Fed meeting and the upcoming holidays, he said.
Most on the Street expect supply to be upward of $500 billion, with Shutz noting there will not be enough “interest rate volatility to cause issuers to dial back.”
Part of this year’s growth was that from a fundamental standpoint, “a lot of the stimulus money given to municipalities is being spent down,” he said, adding that will continue to be the case in 2025, pushing spreads “relatively tight,” Shutz said.
Fund flows were again in positive territory with the Investment Company Institute reporting Wednesday that $1.04 billion flowed into municipal bond mutual funds for the week ending Dec. 11, following $532 million of inflows the previous week. This marks 18 consecutive weeks of inflows, per ICI data.
However, this
Exchange-traded funds saw inflows of $114 million after $478 million of inflows the week prior.
There will continue to be a “building in demand” for munis in 2025 as separately managed accounts and ETFs continue to grow market share, Shutz said.
“They’ve been a big part of the positive net inflows into the market,” Shutz said.
Inflows into mutual funds have returned, but it’s been a more “gradual growth” this year, with performance likely stabilizing in the asset class, he said.
And the “retail investors who ultimately buy mutual funds will get more confidence in putting flows back into that space,” Shutz said.
Historically, during easing cycles, there’s been sustained positive muni mutual fund influence, “so I don’t know that we are in for a dramatic windfall of inflows, but it should be a part of the positive environment,” he said.
FOMC
In his press conference, Federal Reserve Board Chair Jerome Powell said, the rate cut “was a closer call,” as the labor market is cooling while inflation “is broadly on track.” He added, “We see ourselves as still on track to continue to cut” rates next year.
Policy remains “meaningfully” restrictive, he said, but “significantly closer to neutral.” As such the Fed can be cautious about future moves. When asked about the neutral rate, Powell reiterated, it’s not clear what neutral is, “but we’re 100 basis points closer to it.”
Regarding tariffs, Powell said, “it’s very premature to try to make any kind of conclusions.”
While a rate hike next year isn’t likely, Powell said, “it can’t be ruled out.”
“While the Fed opted to round out the year with a third consecutive cut, its New Year’s resolution appears to be for a more gradual pace of easing,” said Whitney Watson, global co-head and co-chief investment officer of Fixed Income and Liquidity Solutions within Goldman Sachs Asset Management.
Changes to the SEP projections were “hawkish,” she said. “We expect the Fed to opt to skip a January rate cut, before resuming its easing cycle in March.”
Don’t expect a January cut, said Brian Rehling, head of global fixed income strategy at Wells Fargo Investment Institute. “We look for the Fed to be much more deliberative and remain in a data dependent holding pattern as it pertains to future rate cuts.”
An uncertain outlook is exacerbated by a new incoming president, said Richard Flax, chief investment officer at Moneyfarm. “Both markets and the Fed are in a wait-and-see mode regarding the impact of these policies on future economic conditions. The key question remains: how much further do rates need to be cut to achieve desired economic outcomes? With the data finally balanced, the Fed is likely to take a cautious approach from here.”
Had a rate cut not been expected, the Fed might have held rates, said Jack McIntyre, portfolio manager at Brandywine Global. “The Fed has entered a new phase of monetary policy, the pause phase. The longer it persists, the more likely the markets will have to equally price a rate hike versus a rate cut. Policy uncertainty will make for more volatile financial markets in 2025.”
The revisions to the SEP suggests “this was a reluctant reduction — one designed to give markets a bit of comfort as the Fed lays the groundwork for a more hawkish approach to policy in 2025,” said Seema Shah, chief global strategist at Principal Asset Management.
“Certainly, the economic and inflation backdrop is not one that screams a need for meaningful policy stimulus, while the incoming administration may give them a severe inflation headache next year,” she added. “The bias should still be further monetary easing, but caution and patience are clearly required at this stage.”
“Since the Fed has started its cutting cycle 10-year yields are 85bps higher and continuing to climb,” noted Byron Anderson, head of fixed income at Laffer Tengler Investments. “The soft landing has been achieved, take the win already.”
Inflation remains “well above goal,” while “unemployment has plateaued and yet the Fed keeps cutting rates,” he said. “Which of its dual mandates is it protecting the economy from by cutting?”
“The Fed seems to have switched back to prioritizing inflation risks over unemployment, readying for a January skip and potentially an extended pause in 2025, if inflationary pressures persist and the economy remains robust,” said Dan Siluk, head of global short duration & liquidity and portfolio manager at Janus Henderson Investors.
AAA scales
MMD’s scale was cut two to three basis points: The one-year was at 2.71% (unch) and 2.65% (+2) in two years. The five-year was at 2.72% (+2), the 10-year at 2.93% (+3) and the 30-year at 3.79% (+2) at 3 p.m.
The ICE AAA yield curve was two to three basis points: 2.77% (+2) in 2025 and 2.71% (+2) in 2026. The five-year was at 2.73% (+2), the 10-year was at 2.95% (+2) and the 30-year was at 3.76% (+3) at 4 p.m.
The S&P Global Market Intelligence municipal curve was cut up to basis points: The one-year was at 2.76% (unch) in 2025 and 2.66% (+5) in 2026. The five-year was at 2.72% (+2), the 10-year was at 2.90% (+6) and the 30-year yield was at 3.72% (+6) at 4 p.m.
Bloomberg BVAL was cut up to five basis points: 2.80% (+2) in 2025 and 2.65% (+1) in 2026. The five-year at 2.73% (+2), the 10-year at 2.98% (+3) and the 30-year at 3.69% (+6) at 4 p.m.
Treasuries sold off.
The two-year UST was yielding 4.357% (+11), the three-year was at 4.358% (+14), the five-year at 4.405% (+16), the 10-year at 4.506% (+12), the 20-year at 4.76% (+10) and the 30-year at 4.655% (+8) at the close.
Primary to come:
The National Finance Authority is set to price Thursday $68.831 million of nonrated River Ranch Project special revenue capital appreciation bonds, terms 2031. D.A. Davidson.
The Hazelden Betty Ford Foundation Project (Baa1///) is set to price $66.945 million of revenue bonds, consisting of $31.79 million of Series A and $35.155 million of Series 2025B. Ziegler.
The Public Finance Authority (//BB-/) is set to price $61.29 million of CFC-LSH-Amplify Lubbock Project multifamily housing revenue bonds, consisting of $54.3 million of Series 2024A-1, $1.465 million of Series 2024A-2 and $5.525 million of Series 2024B. Ziegler.
The Missouri Health and Educational Facilities Authority (//BBB/) is set to price $41.61 million of Lutheran Senior Services Projects senior living facilities revenue bonds, Series 2025A. Ziegler.
Competitive
The Triborough Bridge and Tunnel Authority is set to sell $186 million of second subordinate revenue bond anticipation notes, Series 2024A, at 10:45 a.m. Thursday.
Lynne Funk and Gary Siegel contributed to this report.