Munis Stand Fast and Stable as Treasuries Fall

The municipal market started the holiday-shortened week by standing fast in the face of falling Treasuries and investors loaded with cash to reinvest.

Market participants waited for prices that never materialized, leading to an otherwise quiet trading day.

"We've stood fast, today; we've been stable," said a trader in New York. "We're really unchanged all the way through the list. There was light activity. But there's a lot of money that just has to be put to work."

Muni yields remained unchanged across the curve throughout the day, according to the Municipal Market Data scale. The two-year yield held to end the day at 0.42% for the 16th straight session. Both the benchmark 10- and 30-year muni yields remained at 2.76% and 4.36%, respectively. Each yield has risen 13 basis points in a week.

Treasury yields ended the day lower, but were unable to help kick-start municipals on the day. The 10-year yield fell seven basis points to 3.13%.

The two-year yield dropped five basis points to 0.44%. The 30-year yield slipped one basis point to 4.39%.

Treasury yields hesitated in retracing the steps of their rally over the past few months. As early as April 11, the 10-year yield closed at 3.57%.

On June 24, it had plummeted to 2.86%. More negative news from Europe, specifically Tuesday's downgrade of Portugal's rating by Moody's Investors Service, could lead to another rise.

Less issuance is expected for the holiday-shortened week compared with the previous week. Issuers expect to sell an estimated $1.3 billion of munis this week against a revised $8.2 billion that was sold last week.

There were no significant sales Tuesday on either the negotiated or competitive side of the primary market.

Last week's revised number came in higher than the original estimated figure of $5.62 billion. Year-to-date, the market has averaged more than $3 billion in primary issuance weekly.

The largest bond deal in the negotiated market is slated to arrive Thursday. RBC Capital Markets is underwriting $365.5 million of general obligation bonds for the San Diego Community College District.

At around $28 billion this month in maturing bonds, advance and current refunded bonds, muni investors should have more money on hand to re-invest than they did in June, MMD analyst Randy Smolik wrote in his daily commentary. But little of that was brought to bear on the market Tuesday.

"With only a $1.2 billion tax-exempt primary calendar this week, one would think the odds are tilted to the longs' favor," Smolik wrote. "Yet, despite a healthy bounce in Treasuries, we saw very little indication of buyers reaching for paper. Perhaps the weakness of last week was so pronounced that dealers were still willing to look at nearby bids."

Traders throughout the day remarked on how many of their ilk, if not the market as a whole, were still on vacation. By and large, market participants were content to wait for the pricing and reception of the week's issuance, a trader in Chicago said.

But the week's issuance, light or otherwise, isn't going to move the muni market much this month, the New York trader said. Larger forces will.

"We're not going to see activity with this week's new issuance," he said. "Any activity will come from outside the market, from now through the rest of July. That means Treasuries, the equity market, and the U.S. and world economy; that's where all of the changes will come from. Those are the forces that will move our market."

At the short end of the curve, municipal note yields have reached an all-time low, Moody's wrote in its weekly credit outlook. But these barrel-scraping rates are good for issuers and investors alike, analysts added.

Tax-free yields are at 0.34%, as of June 29, according to The Bond Buyer's note index, while state and local governments are now revving up their wave of note issuance for July, August and September.

This is the time of the year when municipalities have settled their budgets and established any cash-flow needs. And with a low short-term rate environment, heavy note issuers can manage cash-flow shortfalls in an inexpensive way.

"The current index rate implies the aggregate debt-service cost of plugging cash-flow gaps with notes would be about $190 million for municipalities this year, based on our forecast of $55 billion of total issuance," wrote report authors Chris Holmes, director of public finance research, and Dan Seymour, associate analyst. "In 2007, by contrast, note interest costs were closer to $2 billion."

Because Texas issues tax and revenue anticipation notes every year in August, that is when the note calendar typically peaks. Wisconsin, with an $800 million offering of short-term general obligation notes, stands as the biggest issue on the calendar.

This year, Moody's expects note issuance to drop slightly, as traditionally heavy issuers, such as California, Illinois and Michigan have healthier fund balances, and hence, less need to issue short-term debt to bridge gaps in cash flows. The rating agency projected up to $10 billion less than the $65 billion issued in 2010.

For investors, yields for municipal notes are still higher than those for 90-day Treasury bills and commercial paper. They weigh in at less than three basis points and 0.15%, respectively, Moody's said.

That means there should be enough investor demand to include them in their money market funds when the upsurge of new issuance floods the market.

"Collecting a 0.34% tax-free yield on municipal notes has been appealing to taxable money funds even on an after-tax basis," Holmes and Seymour wrote. "It should be noted that municipal notes typically carry longer maturities than 90-day Treasury bills or commercial paper."

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