Reports that the municipal bond market found its savior may have been premature.
Munis have slogged through a tough week in resistance to a mighty rally that ended with a thud last Thursday.
The rally fueled itself with a hopeful promise: that Build America Bonds would alleviate the threat of oversupply in long-term munis.
BABs, enacted under the American Recovery and Reinvestment Act in February, enable state and local governments to sell taxable bonds and either receive a subsidy from the federal government or allow the investor to obtain the subsidy.
The early success of the program sparked hope municipalities would sell paper to pension funds and foreign investors in the taxable bond market, rather than dumping supply onto the retail-investor dominated tax-exempt market.
The result of this scenario would be higher prices for tax-exempts, as they would be more scarce.
Analysts at Barclays PLC estimated BAB issuance of $75 billion a year until the program sunsets on Jan. 1, 2011. Municipalities sold $391.3 billion of debt last year and $429.89 billion in 2007.
“All of a sudden, these BAB deals come, and they’re readily absorbed,” said Chris Mier, muni strategist at Loop Capital Markets. “BAB deals were definitely going to siphon off some issuance from tax-exempts.”
Tom Albright, who manages Kentucky and Utah funds at Aquila Group of Funds, described BABs as “draining bonds out of the pipeline” of the tax-exempt market, making tax-exempt paper scarcer and tilting the supply-demand pricing in bondholders’ favor.
The yield on the 30-year point of Municipal Market Data’s triple-A yield curve plunged 50 basis points from March 27 to April 22. Then the market snapped back, with the triple-A yield climbing 15 points in five days, according to MMD.
The Bond Buyer 20-bond index of 20-year general obligation bond yields, the 11-bond index of higher-grade 20-year GO yields, and the one-year note index of one-year yields all jumped 13 basis points last week.
The three indexes show yields of 4.7%, 4.45%, and 0.72%, respectively.
The weekly average yield to maturity on The Bond Buyer 40-bond municipal bond index finished at 5.41%, which is up four basis points from last week’s 5.38%. It remained below the 5.51% average from two weeks ago, for the week ended April 16.
The revenue bond index, which measures 30-year revenue bond yields, rose eight basis points to 5.57%.
While many traders and investors say it is normal to take a breather after such a fierce upswing, some believe the rally overstretched.
Brokers and dealers stocked up on bonds during the run, said Michael McKenna, senior vice president of trading at GMS Group in Livingston, N.J. These dealers now have too much inventory and would prefer to sell bonds.
“Some accounts and dealers started getting proud; I saw some hoarding of bonds,” McKenna said. “The Street for the most part is fairly heavy right now. The guys that should be buying bonds are sellers.”
He said selling bonds to retail investors became much more difficult over the past week. Yields are creeping up “trying to find a level where retail cares again.”
Another trader in New York said the stalled rally comes down to simple math. Retail investors like 5% yields on 30-year munis.
The farther yields fall from 5%, the less retail investors want to buy, this trader said.
“At this point, retail is a little bit reluctant to commit,” the trader said. “Build America Bonds generated a lot of buzz; we had a lot of retail people inquiring about the bonds.
The muni trading community got a little bit overenthusiastic about what it would actually mean in terms of supply and demand in the municipal market.”
Last week’s giveback offers room for interpretation.
While the BAB rally clearly ran out of steam, it was a rough week for fixed income in general.
Treasury bonds suffered more than munis amid further signs of a potential recovery in financial markets.
The Federal Reserve in its statement at the conclusion of its policy-setting meeting Wednesday acknowledged the contraction in the economy slowed last month.
The Standard & Poor’s 500 index is up 27% since March 9 and 3.6% since last Thursday. Talk of “green shoots” in credit markets is by now cliched.
Prospects for a rebound in financial markets pushed investors out of the Treasury, the safe haven of choice during the credit crisis.
The Treasury’s 10-year note yield rose 20 basis points to 3.13% during the past week. This is the highest yield for the 10-year note in almost six months.
The Treasury’s 30-year bond yield rose 25 basis points to 4.05%, the highest yield since Nov. 13.
