The third quarter of 2024 saw a rally in both the Treasury bond market and the municipal bond market.
The Treasury bond market saw the 10-year US Treasury bond yield move from 4.479 at the beginning of the quarter to 3.797 on September 26th. The move in munis was more muted, with 10-year AAA munis going from 2.84 to 2.63 over the course of the quarter.
To wit, the end of the second quarter saw the 10-year bond yield move from a 4.28 % on the eve of the June 27th Biden-Trump debate to 4.47% by July 1st. We believe this change was a direct result of President Biden’s poor debate performance and a market assumption that we were looking at a sweep of both houses of Congress as well as the White House by Republicans. The thought process is that undivided government tends to produce unchecked spending and that the markets view this outcome as potentially inflationary.
Within a few weeks, the president stepped off the ticket. With Vice President Harris installed at the top of the ticket we saw polls narrow, and the assumption was that divided government was a more likely outcome. This viewpoint tended to calm markets, but the real catalysts were lower numbers than expected on nonfarm payrolls as well as a downward revision to prior months. This was true for both June and July payrolls. In addition, inflation numbers have continued to grind down, with year-over-year headline inflation softening from 3.3% at the end of May to 2.5% at the end of August. This was all punctuated by the Federal Reserve’s decision to cut the short-term fed funds rate 50 basis points on September 18th, from 5.25–5.50% to 4.75–5.00%. While there was almost nonstop discussion in the press about 25 or 50 basis points, Chairman Powell did go out of his way to say that if they had had the data they had on Sept 18th back at the meeting in late July, they would have cut 25 basis points then rather than standing pat.
As you can see from the chart below, Treasury yields declined more than AAA muni yields did across the board. Part of the explanation for this is related to municipal supply. Muni issuance has been heavy as of late, running 35% ahead last year. Particularly in the third quarter, supply has been heavy; and this is muni issuers trying to get ahead of the elections. The common wisdom among issuers is that there is more volatility as we get closer to the election (which remains a virtual toss-up as this commentary is written). This heavy supply has kept munis a bit squishy.
Year | TSY Yield 9/26/24 | TSY Yield 6/28/24 | Change in Yield | MMD Yield 9/26/24 | MMD Yield 6/28/24 | Change in Yield |
2 | 3.61 | 4.76 | - 115 bps | 2.30 | 3.11 | - 81 bps |
5 | 3.56 | 4.38 | - 82 bps | 2.31 | 2.89 | - 58 bps |
10 | 3.80 | 4.4 | - 60 bps | 2.63 | 2.84 | - 21 bps |
30 | 4.15 | 4.56 | - 41 bps | 3.52 | 3.72 | - 20 bps |
Source: Bloomberg
Attached is a chart showing the spread between 10-year and 2-year paper for both Treasuries and AAA munis going back five years. As you can see, the 2s/10s spread has just recently turned positive after being negative for 26 months. It went negative on 7/5/22 and turned positive on 9/5/24.
The normal state of affairs for the respective bond markets is for the muni curve to be STEEPER than the Treasuries curve. That’s really for two reasons. First, the tax exemption drives muni yields lower than yields on Treasuries – particularly in the front of the yield rather than further out. The other reason is that liquidity and credit risk on high-grade tax-free munis, though small in our opinion, does traditionally rise further out on the yield curve.
The yield curves have just disinverted, which usually happens as the Fed embarks on a short-term rate-cutting program, as they are now. We expect further steepness to come, and the real question is whether that occurs from short-term rates dropping, longer-term rates rising somewhat, or a combination of both. That outcome will be driven by inflation numbers, job numbers, and the election outcomes. We will keep readers up to speed.
John R. Mousseau, CFA
Chief Executive Officer & Director of Fixed Income
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