Eye-popping declines in muni yields on Thursday might finally prod investors into accepting low yields and prompt issuers to take advantage of some of the lowest borrowing costs in history.
Yet the nosedive in tax-free paper was merely a sideshow as the Federal Reserve’s monetary policy statement on Wednesday initiated a global rush to safe havens.
The Fed’s decision to redeem $400 billion of short-term Treasuries over the next nine months and exchange them for debt maturing between six and 30 years from now prompted a staggering rally in longer-term bonds.
The 30-year Treasury yield fell 57 basis points in the week to 2.79%, its lowest since the final week of 2008. The 10-year yield dropped 38 basis points to 1.71%, its lowest since the 1950s.
Dubbed Operation Twist in reference to a similar tactic in the 1960s, the Fed’s move was attached to a pronouncement that there were “significant downside risks to the economic outlook.” Coupled with weak data in Europe, that helped spark a global sell-off in equities — the Dow Jones industrial average shed 674 points in two days.
Muni buyers have been balking at low yields recently but the tax-exempt market had little choice but to follow Treasuries as relative valuations hit two-year highs.
The Bond Buyer’s 20-bond general obligation index of 20-year GO yields rushed 22 basis points lower this week to 3.85%, just two basis points above the lowest level since mid-October. The 11-bond GO index of higher-grade 20-year GOs fell 22 basis points to a five-week low of 3.58%, just three basis points from its 43-year low.
The Bond Buyer’s revenue bond index, which measures 30-year revenue bond yields, descended 15 basis points to 4.96%, a 45-week low.
Next to Treasuries, these moves aren’t too big. But the underperformance is nothing to be embarrassed about, said Michael Pietronico, chief executive of Miller Tabak Asset Management.
“If anything, I’m surprised the market was able to generate this kind of gain in one day,” he said, noting Municipal Market Data’s 18 basis point drop among long-term yields. Big rallies can quickly reverse course as traders opt to lock in profits. But the market saw none of that.
“The one thing we see very little of is selling,” Pietronico said. “That’s indicative of a market that has come to grips with the idea that rates are going to remain low for a very long period of time. Replacing bonds may be difficult going forward.”
Pietronico said traditional retail buyers like to keep within the five-year mark but will have to gravitate out to 10 years to retain any cash flow. Money managers will likely reach out to the 15-year spot. Mutual funds, assuming they see inflows, will be the nominal buyers in the long end.
“Taxable investors are going to take a serious look at the muni bond market,” he said. “Absolute yields are so much higher than Treasuries, and there are very few opportunities overseas to get involved in without incurring a lot of credit risk.”
Muni-Treasury ratios finished at 2011 highs on Wednesday, then rose again Thursday. The 30-year ratio jumped nine percentage points over two days to 122.9%, while the 10-year ratio climbed five points to 114.5%. Both are at their highest since April 2009.
“From a taxable investors’ point of view, the muni market is actually an island of tranquility,” Pietronico said. “It could be a destination for a lot of taxable investors — in particular, pensions might take a very serious look at state GO bonds that yield significant amount over Treasuries.”
The weekly average yield to maturity on The Bond Buyer’s 40-bond muni index, which is based on prices for 40 long-term muni issues, declined four basis points to 4.97%, a 46-week low. The one-year note index moved up a basis point to 0.29%.