FOMC Meeting this week

The Federal Open Market Committee (FOMC) meets Tuesday and Wednesday of this week and is expected to announce Wednesday it will raise the target range for the federal funds rate. While it’s widely anticipated the FOMC will increase the fed funds rate three to four times this year, some suggest there could be as many as seven. This first rate hike is expected to be 25 basis points (1 basis point = 0.01%).  Over the past week, the expectations for a 50-basis point increase have lessened as geopolitical tensions persist, though observers are not ruling it out. If all plays out as expected, this will be the first increase in the fed funds rate since 2018.

As the FOMC considers its future monetary policy stance, it will need to find a balance between fighting inflation, while not potentially setting rates so high as to ultimately risk causing a recession. Beginning with their communications over a year ago as inflation concerns mounted, the Fed has indicated it is not on a set course. Rather, each move will be dictated by the mosaic of economic indicators available at the time. However, the Fed is embarking on a path that has not previously been traveled – removing policy accommodation through both increases to the fed funds rate and winding down its asset purchase program. It’s not entirely clear “the data” will be sufficient to indicate probable economic outcomes.

The Labor Department released February inflation numbers on Thursday of last week. The consumer price index increased to an annualized rate of 7.9% in February. This is the highest level since 1982. The economic sectors predominantly affected by the Russia-Ukraine war and driving the inflation numbers are the food, shelter and energy sectors. Commodities, primarily grain, are affected as Ukraine and Russia account for nearly 30 percent of the world’s wheat exports. Global food production, and the price surges that will likely follow, will also see the effect of the interruption of fertilizer production, another major Russian export. The price of oil is also up, resulting in a corresponding increase in gasoline prices. The Wall Street Journal explains a common rule of thumb in which a $10-per-barrel rise in the price of oil increases U.S. inflation by 0.4 to 0.5 percentage points.[1]

Municipal Bond Yields

Yields on U.S. Treasuries at the five-, seven- and ten-year benchmarks are all up this week. The 10-year AAA yield reached its highest level since June 2019. According to Refinitiv MMD, Muni to treasury ratios are 80%, 91% and 96% at five, ten, and thirty years, respectively.

Yields across the entire maturity spectrum have generally increased during this time, as well. In weeks (and months) past, increases in yields have been more predominant on the short end of the maturity spectrum, resulting in a relatively “flat” yield curve.  While governmental entities are generally in reasonable to strong financial positions, boosted by federal stimulus dollars at the state and local levels, credit spreads have been widening of late. This indicates a diminished appetite on the part of investors to take on additional credit risk. This is also reflected in a decline in primary and secondary market trading volume, which tends to further increase spreads due to a lack of price discovery.

The Bond Buyer reported various predictions regarding new issue activity for 2022 at the end of 2021, ranging from $420 billion to $550 billion. Based on year-to-date activity, we are on pace to fall meaningfully short of those forecasts. This week is scheduled for $5 billion of new issuance, which is likely a bit light due to the FOMC meeting and the uncertainty that it brings with it. The last two weeks saw volume of around $7 billion.

Refinitiv Lipper notes the week ending March 10 was the ninth straight week of net outflows from municipal bond funds, the longest stretch since 2018. These outflows are continuing to pressure the municipal market with Refinitiv Lipper reporting $661 million for the week ending March 9and $2.8 billion the week prior.

There is no doubt there is an air of caution surrounding financial markets. Our clients’ bond sales early this week continued to receive multiple bids from underwriters across the country, albeit at higher rates. Contact your Ehlers advisor, we look forward to assisting you in developing a strategy to meet your capital planning needs.

[1] https://www.wsj.com/articles/ukraine-war-oil-gas-prices-inflation-federal-reserve-11647268257?mod=Searchresults_pos1&page=1

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