Traders Gaze Ahead to 2012 for Direction

Traders on a pre-holiday Thursday looked to the new year for direction in the tax-exempt market.

Traders agree that activity should pick up by mid-January. “As long as Treasuries stay where they are and we don’t get huge supply coming in, all indicators point to positive moving forward over the next month to six weeks,” a trader in Los Angeles said. “You’ve got January redemptions and as long as there are no surprises, we’ll be in good shape.”

A trader in Chicago agreed, saying the first week of January could be slow until activity picks up later in the month. “Most people have anticipation for the first week of January, and in the last few years it never seems to meet expectations,” he said. “Last year, it was slow and people didn’t come in looking to immediately put money to work.”

The trader said people will take a “wait-and-see” approach, as there is little motivation to get involved in the market in the ultra-low-yield environment. “The expectation for this year was that eventually rates would start rising and they haven’t,” he said. “So when is that?”

By Thursday afternoon, it was “definitely slower,” the trader said. “It is clearly winding down. Maybe there were too many holiday parties this week.” He added there was “some activity early, but it has pretty much gotten quiet over the past hour. If it’s going to be exciting, it’s not going to be in the bond market today.”

The Chicago trader said there were some bid lists that were interesting but the motivation was not there.

Munis were steady to slightly firmer, according to the Municipal Market Data scale. On Thursday, the two-year yield closed flat at 0.36% for its 12th consecutive session. The 10-year yield fell  two basis points to 1.91%, a new record low as recorded by MMD, beating the previous record of 1.92% set Monday. The 30-year muni yield fell two basis points to 3.62%.

The Securities Industry and Financial Markets Association recommended an early close of 2 p.m., Eastern time, for bond trading on Friday and a full close on Dec. 26. Meanwhile, the secondary market upstaged the primary market Thursday. Trades reported by the Municipal Securities Rulemaking Board showed firming.

A dealer sold to a customer New York City Municipal Water Finance Authority 5s of 2034 at 3.90%, three basis points lower than where they traded Tuesday.

A dealer bought from a customer Massachusetts School Building Authority 5s of 2041 at 4.00%, four basis points lower than where they traded Tuesday. Another dealer bought from a customer Washington 5s of 2041 at 4.01%, three basis points lower than where they traded Wednesday.

Munis were able to hold mostly steady despite a big sell-off in Treasuries. On Wednesday, the five-year and 10-year muni-to-Treasury ratios both closed below 100%. The five-year ratio closed at 98.9%, down from 113.8% on Monday. The 10-year ratio closed at 98%, down from 106.7% on Monday. The 30-year muni-to-Treasury ratio was down to 121.3% from 129.4%.

When looking at defaults over the past year, Income Securities Advisors said the latest numbers show 107 defaults with a par value of $24.6 billion. That compares to 169 in 2010 with a par value of $5 billion. In 2009, defaults spiked at 259 worth $9 billion. These include technical defaults when an issuer fails to make a payment on any obligation to a trustee.

MMD’s Daniel Berger noted that during this year, American Airlines accounted for $3.4 billion of muni defaults while tobacco bonds made up $16.9 billion.

“Combined, American Airlines and the tobacco bonds comprised slightly more than 82% of municipal bond defaults,” he wrote. “Even though the volume of defaults has risen — and may continue to rise due to the presence of $100 billion of outstanding tobacco bonds — we do not believe that that there are systemic problems within the muni market.”

Looking forward to 2012, Morgan Stanley Smith Barney analysts expect a 15-20% increase in supply. Credit spreads should tighten for A-rated general obligation and essential-service revenue bonds, although the trend of downgrades outpacing upgrades should keep spread tightening to a slower pace, said John Dillon.

“The shape of the municipal yield curve is historically steep and we expect it to remain as such, with Fed funds anchored until at least mid-2013 and muni buyers still focused primarily on the first 15 maturities of the yield curve,” Dillon said, adding that his firm recommends six- to 14-year maturities.

Interest rate volatility coming from Treasuries shouldn’t change in 2012. “With Treasuries experiencing unprecedented volatility, municipal bond investors will need to closely monitor these benchmarks for favorable entry points,” he wrote.

Muni-to-Treasury ratios will be another concern. Dillon said he expects the 10-year ratio to remain at elevated levels in the early part of 2012 — hovering between 100% and 120% — and gradually decline to the 95% to 100% range later in the year.

“Municipals simply are not Treasuries and do not experience global flight-to-quality flows which elevate the ratios,” he wrote. “Secondly, we have recently seen the longevity of the federal tax exemption on the table when it comes to tax reform, which makes it unlikely that municipal ratios will revisit the 84% long-term average any time soon.”

For reprint and licensing requests for this article, click here.
MORE FROM BOND BUYER