Municipal bond yields were mostly flat Thursday even as the Treasury market weakened across the curve owing to the return of risk appetite.
“Market is slightly off maybe two basis points here and there on the long end,” a New York trader said.
“There are a few more bid- wanteds out there today than yesterday,” he added, noting that bids have been slightly weaker. “The overall tone is decent although not a whole lot of trades are happening.”
Another trader in New York said the muni market was “pretty muted” despite the Treasury market coughing back some of the gains it registered during the panic of the past few days.
The Municipal Market Data triple-A scale for 10-year tax-exempts ticked up one basis point to 2.91%. The equivalent two-year scale remained at 0.59% and the 30-year scale stayed put at 4.68%.
The 10-year Treasury yield ticked up as much as 10 basis points in morning trading before finishing at 3.24%, or three basis points up from Wednesday’s closing yield of 3.21%.
Treasuries have been a preferred asset this week as investors fret over the fallout from the aftermath of the earthquake, tsunami and radiation fears in Japan. Municipals followed suit early in the week, strengthening 10 basis points combined on Tuesday and Wednesday.
The yield on the 10-year Treasury note declined 13 basis points this week to 3.24%, the lowest level since Dec. 9. And the 30-year Treasury yield dropped 10 basis points this week to 4.42%, the lowest in 11 weeks.
“The flight to quality has helped,” said Bill Walsh, president of the broker Hennion & Walsh. He said municipals might end up weakening at a lag as the flight-to-quality trade retrenches.
“You could see them sort of hanging on the Treasury’s ups and downs,” Walsh said. “Right now you could see them following suit unless the headlines change.”
The Bond Buyer’s 20-Bond GO index of 20-year general obligation yields declined five basis points this week to 4.86%, the lowest level in 14 weeks. The 11-bond index of higher-grade 20-year GO yields also dropped five basis points to 4.60%, another 14-week low.
On the short end, The Bond Buyer’s one-year note index declined two basis points this week to 0.49%, an 18-week low.
The weekly average yield to maturity on The Bond Buyer’s 40-bond municipal bond index, which is based on 40 long-term municipal bond prices, declined three basis points this week to 5.64%.
MYTH VS. REALITY
While traders were celebrating St. Patrick’s Day early, the Securities Industry and Financial Markets Association held two expert panels to discuss the credit quality and structure of the municipal market.
Tim Ryan, president of SIFMA, said the conference titled “Myth vs. Reality: What’s Really Happening in the World of Municipal Bonds?” was organized to give expert analysis to combat “the hysteria of the newspapers.”
Thalia Meehan, team leader of tax-exempt fixed income at Putnam Investments, pointed out in the first panel that public finance defaults totaled $8 billion in 2008, $7.3 billion in 2009, and $2.7 billion last year.
To reach “hundreds of billions” worth of defaults in 2011, as predicted by some outside analysts, the volume of defaults would have to more than quintuple from the cumulative rate of the past three years, Meehan said.
“Everything is not okay,” added keynote speaker Sheila Amoroso from Franklin Templeton Investments. “But the sky is not falling. It’s not Armageddon.”
Amoroso said the overstatement of defaults created a level of fear that’s well beyond what the market will actually see. She said experts in the market have been befuddled just trying to work out where the dire predictions come from.
Outstanding debt from the top 50 local governments totals $83 billion, according to Meehan, so even if they all defaulted in the same 12-month period, another $17 billion would have to default for the outside prediction to become true.
Still, the pessimistic forecasts for heavy defaults have contributed to 17 weeks of municipal bond mutual fund outflows so far.
Amoroso called that sell-off beginning in November “a panic of retail investors,” noting that sophisticated investors stayed put.
“It was a technical-led sell-off that became a negative feedback loop,” she said.
On the subject on bond insurance, the panel agreed that Assured Guaranty Ltd. continues to give shelf space to smaller issuers where investors are less likely to perform their own credit research.
“I think we’ve found the market can function quite well without bond insurance,” said senior municipal credit analyst Thomas Keays from Morgan Stanley. Credit enhancement remains important for smaller issuers, but he said he’s unaware of any small governments having trouble accessing the capital markets.
The second group of panelists looked at hedging problems in the municipal market.
“There are two positions in our marketplace: long, and less long,” said Hector Negroni from Goldman, Sachs & Co. “I’m not pining for the levered market to come back,” but stability brings money into the marketplace, he said.
Panelists said the ability to lever just isn’t there anymore, which hurts the prospect for a return of tender-option bond programs.
Banks are reluctant to use leverage; it’s hard to get, it’s costly, and the perception of credit risk has caused volatility in a once-sleepy market.
That presents problems for longer-term issuance, a problem that Build America Bonds had solved by giving issuers a 35% subsidy to forego the usual tax-exemption.
In the second panel, Robert Amodeo from Western Asset Management Co. called for the return of the BAB program at a much-reduced subsidy rate. He said BABs should be present as “an escape valve” for local governments so they can access broader capital markets, but issuers need to be penalized for using the program rather than rewarded.
BRIGHT DATA
New economic data showed the U.S. economy coasting along at a steady clip with no inflation threat.
The Bureau of Labor Statistics announced the core consumer price index picked up 0.2% in February, placing the annual change at 1.1%, well below the Federal Reserve’s unofficial 2% preferred rate.
The inflation-protected Treasury market implies an expected inflation rate of 2.24% over the next five years.
Initial jobless claims came in at 385,000, a decline of 16,000 from the previous week. That pushed the four-week average down 7,000 to 386,250.
The Philadelphia Fed’s regional manufacturing index climbed 7.5 points in March to 43.4, its highest since January 1984.
“There is no escaping the conclusion that manufacturers, especially those in the East, are seeing a very impressive pickup in business conditions,” economists at Nomura Securities said in a research note. “If other regions are seeing the same sort of gains, the ISM index — currently at 61.4 — could break through to its own new 27-plus-year high.”
