The third quarter of 2023 has seen significant market movements and much uncertainty around the United States’ economic outlook for 2024 as the Federal Reserve attempts to steady inflation. Absolute yields as well as credit spreads have widened meaningfully across the credit spectrum. Additionally, a recent selloff has pared back equity gains from earlier in the year. After rising nearly 16% in the first and second quarter, the S&P has fallen by roughly 5% since the end of June. This is likely a disappointing development for some university endowments, as they looked for larger gains to help recover from lackluster performances in 2022. Below are several market developments that Blue Rose has observed throughout the quarter.
Interest Rate Movements and Impact
A key trend from the third quarter of 2023 was interest rate movements. In the municipal space, the MMD tax-exempt benchmark rate saw a steady increase throughout the course of the quarter. Since July 1st, the index has moved higher by anywhere from 65-93 basis points, with a median rate movement of 85 bps. The largest increases were seen beyond the 7-year tenor of the curve where rates rose between 84-93 bps. Treasury rates have also notched significant upward movements since the beginning of the quarter. The 1-to-5-year tenors increased by 54-67 bps while the longer-dated tenors experienced larger gains of 80-95 bps. Rising yields have also put pressure on equity markets, as the relative benefit of equity investments diminishes when bonds, and in particular “risk-free” treasury bills, can yield upwards of 5% in the current environment.
These rate increases have contributed to decreased issuance volume across the municipal market, particularly within the taxable market. Year-to-date issuance across higher education and non-profit institutions is down roughly 29% from this time last year and almost 41% down from this time in 2021. Tax-exempt issues have totaled $12.3 billion so far in 2023, compared to $14.2 billion at this time last year. However, the largest divergence exists in the taxable market where year-to-date issuance is down from $11.2 billion last year to just $1.9 billion through the first nine months of the year.
Economic Developments
Some of these rate movements and general uncertainty can be attributed to the Federal Reserve’s continued efforts to curb inflation that has remained stubbornly elevated from pre-pandemic levels. The Fed has come a long way in its battle against inflation, with the CPI falling from over 9% last summer to 3.7% in September. However, the July and August reports saw a reversal in the 12-month string of successive monthly decreases, with the index rising by 0.2% in July and 0.6% in August before holding flat in September. With fresh data indicating that the economy still remains strong, markets may be digesting that the “higher for longer” rate narrative for the Fed holds true. Recently, Jerome Powell suggested higher yields could allow the Fed to pause rate increases. Economic sentiments are changing as well around the probability of a recession in the United States. According to the Bloomberg U.S. Recession Probability Index, there is roughly a 55% chance of the country entering a recession within the next year. This is down roughly 10% from the beginning of the quarter and the year, as the index has hovered around 65% since the beginning of 2023.
As we begin the final stretch towards the end of the year, the municipal market outlook remains mixed. Given the elevated rate environment, it seems unlikely that bond issuance, whether taxable or tax-exempt, will accelerate meaningfully before the end of Q4. This trend will likely continue into 2024 until market volatility abates and/or interest rates move lower. Relief may be coming: the Bloomberg Economic Forecast projects that rates will begin to ease sometime in the first or second quarter of next year. In the meantime, if you would like to discuss capital plans in the context of these market conditions, please schedule some time to connect with your Blue Rose Advisor.
Comparable Issues Commentary
Shown below are the results of two higher education financings from the Pacific Northwest that priced near the end of August. On August 22nd, Washington State University (“WSU”) priced its tax-exempt General Revenue Refunding Bonds, Series 2023. Exactly one week later, Boise State University (“Boise State”) priced its tax-exempt General Revenue Project Bonds, Series 2023A. WSU’s transaction was purely a refunding and served to refinance a portion of the University’s outstanding General Revenue and Refunding Bonds, Series 2013. In contrast, Boise State’s transaction was solely issued for new money projects, with bond proceeds being used to finance a residence hall for new first-year students.
A primary similarity between the two deals is their ratings: both schools’ bonds carry a “Aa3” rating from Moody’s Investor’s Service and an “A+” rating from S&P Global Ratings, although WSU used bond insurance for its transaction, giving its bonds a “AA” insured rating from S&P. Boise State’s issuance was the larger of the two financings, coming in at $43.495 million in total par amount whereas WSU’s transaction was about half the size of Boise State’s, at $20.275 million of par amount. Both deals were sold with a standard 10-year par call option in 2033. As a new money issuance, Boise State’s bonds were structured with a fairly typical 30-year level debt service amortization, with serial maturities from 2024-2041 and three term bonds in 2043, 2048, and 2053. WSU’s refunding transaction featured serials from 2024-2033 with one additional serial maturity in 2038. The two deals were similar in coupon structure, with both utilizing exclusively 5% coupons, except for Boise State’s 2043 and 2053 term bonds, which used 4.25% and 5.25% coupons, respectively.
From the beginning of August to WSU’s pricing date, MMD jumped considerably across the curve. Excluding the 1-year tenor, which saw an 8 bp uptick, rates moved higher by 15-34 bps with the largest movements being concentrated at the 7-year point and beyond, where they increased by at least 30 bps. On pricing day, rates continued to climb by another 4-6 bps across the curve. Washington State was ultimately able to achieve spreads to MMD of 16-41 bps.
In the ensuing week, MMD remained relatively flat with the 1-year tenor decreasing by 2 bps and modest upticks of 2-5 bps in the 7-9-year tenors. Rates moved slightly lower in a few early tenors on pricing day but were otherwise largely unchanged. Boise State was ultimately able to achieve spreads to MMD of 16-50 bps on its serial bonds, with the 5% and 5.25% coupon term bonds pricing at a spread of 51 bps and the 4.25% coupon 2043 term pricing at a spread of 69 bps.
Recent Bond Sales
| Issue Detail | Maturity | Coupon | Yield | +/- "AAA"1 |
|---|---|---|---|---|
|
$20,275,000 General Revenue Refunding Bonds Series 2023 Aa3 (Moody's) AA (S&P Insured) A+ (S&P Underlying) 8/22/23 Sale Negotiated Barclays |
10/1/24 | 5.00% | 3.45% | 0.16% |
| 10/1/25 | 5.00% | 3.32% | 0.13% | |
| 10/1/26 | 5.00% | 3.26% | 0.20% | |
| 10/1/27 | 5.00% | 3.20% | 0.24% | |
| 10/1/28 | 5.00% | 3.18% | 0.25% | |
| 10/1/29 | 5.00% | 3.18% | 0.28% | |
| 10/1/30 | 5.00% | 3.19% | 0.31% | |
| 10/1/31 | 5.00% | 3.21% | 0.35% | |
| 10/1/32 | 5.00% | 3.24% | 0.36% | |
| 10/1/33 | 5.00% | 3.35% | 0.40% | |
| 10/1/38* | 5.00% | 3.86% | 0.41% | |
|
*Priced to a 10/1/2033 call date at 100%. 1Spreads to AAA MMD are based on end-of-day uninterpolated MMD on the day of pricing for each issue. |
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| Issue Detail | Maturity | Coupon | Yield | +/-"AAA1" |
|---|---|---|---|---|
|
$43,495,000 General Revenue Project Bonds Series 2023A Aa3 (Moody's) AA (S&P Insured) A+ (S&P Underlying) 8/29/23 Sale Negotiated Barclays |
4/1/24 | 5.00% | 3.43% | 0.16% |
| 4/1/25 | 5.00% | 3.38% | 0.22% | |
| 4/1/26 | 5.00% | 3.28% | 0.24% | |
| 4/1/27 | 5.00% | 3.23% | 0.30% | |
| 4/1/28 | 5.00% | 3.19% | 0.29% | |
| 4/1/29 | 5.00% | 3.19% | 0.29% | |
| 4/1/30 | 5.00% | 3.19% | 0.29% | |
| 4/1/31 | 5.00% | 3.24% | 0.33% | |
| 4/1/32 | 5.00% | 3.26% | 0.33% | |
| 4/1/33 | 5.00% | 3.29% | 0.34% | |
| 4/1/34* | 5.00% | 3.36% | 0.34% | |
| 4/1/35* | 5.00% | 3.44% | 0.34% | |
| 4/1/36* | 5.00% | 3.58% | 0.36% | |
| 4/1/37* | 5.00% | 3.70% | 0.36% | |
| 4/1/38* | 5.00% | 3.83% | 0.38% | |
| 4/1/39* | 5.00% | 3.90% | 0.41% | |
| 4/1/40* | 5.00% | 4.01% | 0.48% | |
| 4/1/41* | 5.00% | 4.08% | 0.50% | |
| 4/1/43 | 4.25% | 4.37% | 0.69% | |
| 4/1/48* | 5.00% | 4.36% | 0.51% | |
| 4/1/53* | 5.25% | 4.42% | 0.51% | |
|
*Priced to a 4/1/2033 call date at 100%. 1Spreads to AAA MMD are based on end-of-day uninterpolated MMD on the day of pricing for each issue. |
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Interest Rates
Ben Pietrek | bpietrek@blueroseadvisors.com | 952-746-6055
Ben Pietrek joined Blue Rose in 2021 and works as an Analyst. In his role Mr. Pietrek is responsible for providing analytical, research, and transactional support to the lead advisory team serving higher education, non-profit, and government clients with debt advisory, derivatives advisory, and reinvestment advisory services. He is also responsible for credit and debt capacity analyses.
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