Muni Market Braces for Fed Rate Cut as Supply Looms

The municipal bond market remained relatively quiet on Friday, with yields barely budging as investors awaited the upcoming Federal Open Market Committee (FOMC) meeting, where a rate cut is widely expected. Despite the lull, the market has shown signs of improvement, with fund flows turning positive and the municipal yield curve starting to steepen in anticipation of the rate-cutting cycle.

Navigating the Shifting Muni Landscape

Muni Yields Remain Stable Ahead of FOMC Meeting

The municipal bond market saw little activity on Friday, with triple-A muni yields remaining largely unchanged across the yield curve. This relative stability came as investors braced for the upcoming FOMC meeting, where the central bank is expected to deliver the first rate cut in four years. The lack of significant movement in muni yields contrasted with the more pronounced gains seen in U.S. Treasuries, particularly at the front end of the curve.

Muni Curve Steepening in Anticipation of Rate Cuts

The municipal bond market has been closely tracking the movements in the U.S. Treasury market, with the 2s10s Treasury curve steepening to positive territory. While the curve has flattened somewhat since last Friday, it has not re-inverted, suggesting that the market is anticipating a faster decline in yields. This dynamic has led to a steepening of the muni curve, particularly in the 3s5s and 5s10s segments, as investors position themselves for the expected rate-cutting cycle.

Muni Ratios Remain Attractive for Investors

Despite the municipal bond market's underperformance relative to U.S. Treasuries and corporate counterparts, the asset class has still managed to deliver solid returns, with the Bloomberg Municipal Index up 0.66% so far in September and 1.97% year-to-date. The market tone has improved, allowing investors to absorb the heavy supply without major issues. This has been aided by the return of positive fund flows, as investors have realized that rate cuts are on the horizon.

Muni Curve Poised for Further Steepening

Analysts at Barclays expect the municipal curve to continue steepening as the market becomes more certain about the impending rate-cutting cycle. They suggest that the long end of the curve may still offer opportunities for investors looking to extend their duration, as the curve remains relatively flat in this segment. The muni ratios have also remained well-behaved, with levels that are fair to slightly cheap based on historical data, providing potential entry points for investors.

Upcoming Supply and Potential Risks

The municipal bond market is set to face a relatively lighter supply calendar in the coming week, as investors await the first rate cut in a long while. However, issuance is expected to pick up after that, with the 30-day visible pipeline currently at relatively manageable levels. The market is positioning itself for the annual year-end run, with ratios becoming more attractive.One potential risk factor on the horizon is the possibility of a "red wave" in the November elections, which could pose a threat to the tax-exempt status of municipal bonds. However, the probability of such an outcome has declined somewhat after the recent presidential debate, according to PredictIt. Nonetheless, investors are likely to remain cautious in the near term as they navigate the evolving municipal bond landscape.