Who needs Build America Bonds to keep borrowing costs low? The tax-exempt rally extended for an 18th session Thursday as yields fell to their lowest levels since November.
“We had a strong market today,” said a trader in New York. “Instead of incremental basis point moves, we’re seeing four-to-five basis point changes.”
Muni yields fell as much as seven basis points on the long-end, according to Municipal Market Data. Short-term rates were steady and intermediate yields fell two to six basis points.
The benchmark 10-year yield finished five basis points lower at 2.74%, its lowest since Nov. 12, 2010, and 53 basis points lower than a recent peak of 3.27% on April 11.
The two-year yield was stable at 0.54%, its lowest since Nov. 15, and the 30-year yield fell five basis points to 4.45%, its lowest since Dec. 6.
“Just when you think the market can’t go any higher, it does,” said a trader in Chicago. “The market feels very strong here and buyers just want to get something.” Yet numerous traders were cautious about whether the tax-exempt rally could last.
“Soon you’re going to come to some kind of reversal — people will need to catch their breath. That’s the only concern,” the New York trader said.
“We’re starting to get into lower yields where people don’t feel so enticed to play,” another New York trader said.
The fight for tax-exempt paper has been particularly helpful to issuers lucky or smart enough to borrow in the market this week.
The biggest deal sold this week was $600 million of New Jersey Transportation Trust Fund Authority bonds, where a two-day order period was instead absorbed in a single day.
“The cut in yields on the long-end was almost 20 basis points,” said Guy LeBas, chief fixed-income strategist at Janney Capital Markets. “That’s a pretty obscene revision.”
The volatility reflects how little price discovery is in the market. With so few bonds being sold in the primary market, it’s tough to get handle on where real prices are, Lebas said.
Matt Fabian, managing director at Municipal Market Advisors, said the muni rally could easily reverse itself.
“It’s an analogous situation to last summer, when BAB-related scarcity drove tax-exempts to record low yields that eventually had a violent correction when tested with selling pressure,” he said. “Right now, this is a great market to be selling in to; not a good time to be buying.”
The drivers guiding the rally continue to be the same — there’s little supply and Treasuries are providing pressure.
The Bond Buyer’s 30-day visible supply, which measures the volume of bonds expected in the next 30 days, was just $7.661 billion on Thursday. It measured $9.3 billion in mid-January, and the first quarter ended up seeing the slimmest volume for any quarter in 11 years.
“You continue to have no calendar,” the second trader in New York said. “Everyone you talk to is pushing expectations for a return of new-supply further out.”
He said predictions for 2011 issuance are rapidly falling to the $200 billion to $225 billion range, versus $300 billion a few weeks ago.
“Pretty soon we’ll be six months into the year with not a lot of issuance to show for it,” the trader added.
Citi’s chief muni analyst George Friedlander recently lowered his 2011 estimate to $240 billion from $275 billion. “I keep cutting it and cutting it and cutting it,” he told the National Federation of Municipal Analysts Thursday.
An interesting question is whether this lack of supply is structural rather than just short-term, said Lebas. He said the conservative outlook from state and local government leaders could reduce capital spending well beyond this year.
“With fewer capital projects in the works — possibly for a number of years down the road — there is less need for issuance in the short-term,” he said. “It’s too early to be certain of this trend, but there are subtle hints that issuance could be lower for a long time.”
A lack refunding issuance also limits new product. Issuers took advantage of the market last year to refund bonds, when tax-exempt issuance was scarce owing to the popularity of taxable Build America Bonds. But in the first four months of this year, refunding volume fell 41% to $19.3 billion, according to Thomson Reuters.
If expectations for new supply continue to fall, it’s not clear why muni yields would back up.
“I don’t see any headwinds being that strong, short-term,” said the second New York trader. He added that the Street is anticipating Friday’s non-farm payrolls report to disappoint, which could prove a boon to safe haven assets.
“I’m not saying there’s a capitulation trade, but what’s going to be the catalyst? Probably not tomorrow’s number,” he added. Predictions for April’s job growth averaged 200,000 early in the week but have since fallen to 185,000.
But LeBas said the falling forecasts means cash could flow from fixed income and back into equities if the report is more positive than anticipated.
“Expectations are really low and the whisper number — what’s going around the market — is probably closer to 165,000,” he said. “So a result in line with consensus expectations could be pretty positive for the [equity] market and create a short-term back up in [fixed income] rates. That said, the muni market has been quiet this week so they may not follow suit as aggressively.”
A broad rally in Treasuries provided further boost for tax-exempts.
The yield on the Treasury’s 10-year note declined 16 basis points this week to 3.16%, a 22-week low. The 30-year bond also dropped 16 basis points in the week to 4.26%, a 23 week low.
MMD analyst Randy Smolik attributed much of the gain in fixed income assets to a bursting commodity bubble, as crude oil futures for June declined 8.6% Thursday to $99.80 per barrel.
As cash exited those riskier trades, safe haven assets got a boost.
“Although some felt in April that the completion of QE2 in June would weigh on Treasuries, they underestimated how easy money created a bubble in commodity prices and propped up the stock market as well,” Smolik wrote. “Now that commodity traders realized that the trail of cheap money was nearing an end, the bubble has burst.”
The ongoing rally showed up clearly in the Bond Buyer’s weekly indexes, where several indexes are at calendar year lows.
The Bond Buyer’s 20-Bond general obligation index of 20-year GO yields declined 17 basis points this week, to 4.69%, a 22 week low. The 11-Bond GO index of higher-grade 20-year GO yields dropped 16 basis points this week, to 4.43%, another 22 week low.
The Revenue Bond Index, which measures 30-year revenue bond yields, declined six basis points this week to 5.45%, the lowest since January 6. The Bond Buyer’s One-Year Note Index dropped four basis points this week to 0.46%, a three week low.
The average weekly yield to maturity of the Bond Buyer Municipal Bond Index, which is based on 40 long-term bond prices, declined six basis points to 5.52%, the lowest since the final week of 2010.
