Munis Motionless Ahead of Supply Deluge

Municipal bonds were motionless Monday as traders braced for a mammoth supply of new state and local government debt over the coming month.

One trader in Milwaukee described a market in a “holding pattern” ahead of three key developments this week: the elections, the Federal Reserve’s announcement on quantitative easing, and the supply of new bonds.

Thomson Reuters analyst Randy Smolik, in his daily commentary, wrote “many game-changing developments” could hit the market on Wednesday, between the Fed announcement and the elections.

Until then, though, many traders are sitting on their hands.

“Market participants are mostly frozen until direction is determined by mid-week,” he said.

The Municipal Market Data triple-A yield curve was unchanged at every maturity, with the benchmark 10-year at 2.51%.

The S&P National AMT-Free Municipal Bond Fund, which with $2.2 billion is the biggest municipal exchange-traded fund, added one cent to $105.30. The fund is a theoretical real-time proxy for the S&P National AMT-Free Municipal Bond ­Index.

Traders said looming supply is the biggest overhang to the market right now.

The Bond Buyer visible supply, which measures how much municipal debt is scheduled for sale over the next 30 days, reached an uncommonly high $17.5 billion last week. The supply is currently at $13.6 billion.

Municipal governments sold $340.5 billion in the first 10 months of the year, according to Thomson Reuters, up 1.6% from the comparable period in 2009.

“It just makes people stay close; they don’t really want to expose themselves,” a trader in New York said. “Everybody’s just kind of chilling right now.”

This week’s supply is a less-than-terrifying $7 billion, but that only heightens concern about highly concentrated batches of supply in future weeks.

JPMorgan analysts Alex Roever and Chris Holmes in a note to clients wrote that the impending supply glut could prove troublesome because it includes a lot of lower-tier credits, particularly single-A and triple-B rated airports and housing finance agencies.

“Heavy supply has been the number one driving force in the muni market over the last few weeks, and will continue to set the tone until mid-December,” they wrote. “The total volume of supply is by-and-large the most important factor, and will likely continue to pressure tax-exempt spreads wider.”

Dealers’ inventories are heavier than they were two months ago, Roever and Holmes said, possibly forcing spreads upward.

Heavy supply pushed triple-A yields up about 40 basis points in the fourth quarter last year, and Roever and Holmes expect supply in this year’s fourth quarter to be even heavier.

Municipals sustained a rough week last week as the market struggled to digest nearly $10 billion of new bonds.

The yield on the benchmark 10-year triple-A municipal bond drifted up 12 basis points to 2.51% for the week, according to the MMD scale.

The market has exhibited general weakness since yields touched their all-time lows in August.

The entire bond market is awaiting an announcement from the Federal Open Market Committee on Wednesday that will reveal how much government debt the Fed will buy.  Estimates have ranged anywhere from a few hundred billion dollars to $2 trillion.

The market has already priced quantitative easing into bonds.

The yield on the 10-year Treasury has come down 10 basis points since the minutes from the last Fed meeting, released on Sept. 21, hinted at further easing. The yield on the two-year Treasury has come down 12 basis points.

Treasuries were little-changed Monday. Yields on Treasuries five years and in strengthened two basis points, while longer-dated Treasuries weakened one basis point.

This has been a recurring theme the past few weeks as investors hash out the effects of QE. The Fed has concentrated its purchases of Treasuries to maturities between two and 10 years.

Some participants in the bond market worry that the Fed will not explicitly commit to as big an easing package as people hope for, possibly inflating yields.

“Municipal participants are anticipating as best we collectively are capable of before the meeting next week,” Bank of America Merrill Lynch muni strategist John Hallacy wrote in a report last week.

Hallacy said the elections could be just as important as the QE announcement, because of their implications for taxes and the extent of federal aid to state and local governments.

Another facet of the municipal market hinging on the elections is the potential extension of the Build America Bonds program.

A bill proposed by Sen. Max Baucus that would extend the program could still be approved by the House this year.

Spreads on BABs over like-dated Treasuries have remained above 200 basis points since June, according to a Wells Fargo index tracking the sector. In the past week, spreads have bled out about 15 basis points, to 238.

Activity in the primary market was light. The Melrose Park, Ill., priced $19.5 million of refunding bonds in two series, one with maturities through 2018 and one through 2019. Mesirow Financial was underwriter  on the bonds that priced at 4.07% with a 4% coupon in the 2018 ­maturity and 3.35% 3.13% coupon in 2019.

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