Municipals Weekly: The case for richer ratios & a flatter curve

Research evidence excerpt

Municipals Weekly: The case for richer ratios & a flatter curve

H26.

On Wednesday, Fed Chair Warsh indicated that inflation risks are down and that the Fed

is determined to reach its desired 2% target. In the meantime, he indicated that the Fed

will be flexible on the balance sheet. In retrospect, since the first Fed rate cut in Sep-24,

large curve steepening and high long-term yields caused the Fed to change its tune as

the new Chair starts his term. In our view, such a new policy combination of higher

policy rates and possible expansion of the Fed’s balance sheet is more likely to succeed

in controlling long-term yields.

For the time being, short of an actual rate hike, Treasury yields are likely to stay range

bound in July and for much of the summer. An actual rate hike should reinforce curve

flattening below recent low levels. Our rate strategists forecast that the 2s10s Treasury

should go to 0bp in 2026, and the 10s30s should stay around 50bp (see their Global

Rates Viewpoint: Mid-Year: It’s a small world after oil 25 June 2026).

Strong demand conditions will compress long end ratios

The muni market looks a lot clearer and cleaner than the Treasury market in July. We

expect $50bn of issuance during the month and $70bn of principal redemptions and

coupon payments. Meanwhile, inflows to mutual funds and ETFs are consistently large

and positive. The supply/demand mismatch in July may become more acute than over

the past two months, especially if long end Treasury curve flattening resumes. These

conditions should keep munis well bid and muni/Treasury ratios tight during July and

August.

Indeed, somewhat opposite supply/demand dynamics between the Treasury market and

munis will continue to press muni/Treasury ratios even lower, particularly at the long-end