The municipal bond rally paused Monday with tax-exempt prices holding at calendar-year highs. Traders said they are awaiting new deals this week before moving in either direction.
“Our market was essentially unchanged — there was a whiff of softness but you really couldn’t pin it down,” a trader in New York said. “There were no bid-wanted lists of any size or note, and the news affecting the rest of market had no impact on munis.”
The steady tone marks the 20th session tax-exempts have been stable or firming, according to Municipal Market Data.
The 10-year tax-exempt yield remained 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 held at 0.54%, its lowest since Nov. 15, and the 30-year yield stayed at 4.45%, its lowest since Dec. 6.
“Seemed like the tax-exempt market is stuck in neutral until this week’s deals are priced and the market can assess how well paper is getting distributed,” Randy Smolik wrote in a daily commentary for MMD. “Dealers still sense there is plenty of cash on the sidelines from bond redemptions and this side of the demand equation will continue to weigh on buyers as hefty redemptions in June hit.”
The 10-year Treasury note broke through a key resistance barrier at 3.15% in early trading and finished the day at 3.14%, two basis points lower than Friday’s closing level and the richest price since Dec. 27, 2010.
The two-year note finished at 0.55%, one basis point down from Friday’s close. The 30-year bond yield, by contrast, rose one basis point to 4.31%.
Since April 11, munis have outperformed Treasuries. The 10-year tax-exempt yield has fallen 53 basis points in the period, while the 10-year Treasury yield has fallen only 43 basis points.
Still, a trader in Chicago said “there’s no doubt that Treasuries are leading the way,” though munis are outperforming on the margins and would likely continue to do so this week.
He predicted that the 10-year muni-to-Treasury ratio could soon rally to 85% versus a range of 86.4% to 92.8% in the past two months.
“Treasury yields are moving lower and the muni market will be somewhat dependent on that,” he said. “Visible supply has ticked up a little bit but it’s still a pretty light calendar out there.”
The muni market is readying to absorb $4.4 billion of new issuance this week, led by a $600 million Virginia Department of Transportation deal and a $500 million offering from Puerto Rico.
Both are set to price Wednesday, in addition to a $322 million issue from the Dormitory Authority of the State of New York and $286 million of bonds from Wisconsin.
“Wisconsin is probably what people are looking for in terms of price discovery,” the New York trader said, pointing out that it’s a large general obligation issue.
This week’s issuance compares with $4 billion of new offerings last week, but issuance remains slight next to the $8 billion average weekly tally from 2010.
The Chicago trader said tax-exempt rates could begin to climb, but noted that demand for new deals has been great recently.
JPMorgan brought to the retail market $206.3 million of improvement revenue bonds for the Fairfax County, Va., Economic Development Authority. The deal, rated Aa2 by Moody’s Investors Service and AA by Standard & Poor’s and Fitch Ratings, offered yields from 1% in 2014 to 4.29% in 2031.
Recent analysis from the muni world has been optimistic that the rally indicates more than just temporary strength.
“The worst is behind us,” Peter Hayes, portfolio manager at BlackRock, argued in a commentary published Monday.
Hayes noted that state revenues have been up for the past four quarters, spending is being cut, and budget negotiations are becoming smoother. He said the best opportunities lie in stepping out the yield curve to intermediate bonds, where significant pickup over shorter bonds can be found without taking on the principal risk of longer-term paper.
Lower-rated bonds can offer attractive yields as the market continues to adjust to a world with limited bond insurance, Hayes added.
According to MMD, the spread in 20-year munis between triple-A and triple-B bonds was 173 basis points last week, the widest in 15 months. The same spread was 142 basis points at the start of the year.
“We believe the great majority of the municipal bond market represents a high-potential, low-risk opportunity,” he added. “Outside of high-yield, the local government segment is the most vulnerable, but not nearly as endangered as some of the headlines would lead you to believe.”
Analysts at Citi found it particularly interesting that the rally has kept going despite a lack of support from muni mutual funds, which have now seen 25 weeks of outflows — last week, outflows even expanded despite the 30-year muni rallying 13 basis points.
“Bond funds are traditionally a strong source of demand and support for tax-exempts, and the rally in the face of continued outflows lends credence to the notion that crossover buyers and [separately managed] accounts have been active,” chief muni analyst George Friedlander wrote in a note published Friday.
The MCDX index, a benchmark index of prices for credit defaults swaps referencing 50 different municipal entities, fell dramatically over the last week to a 52-week low.
Friedlander cited the index in noting how much investor confidence has improved since the beginning of the year. He noted, for instance, that “credit fears are not the dominating force at present.”
But Chris Holmes and Alex Roever, fixed-income analysts at JPMorgan, said the tightening represents a CDS buying opportunity, as yields could rise once a hefty supply of issuance returns to market, as they expect.
“Our bias toward widening tax-exempt bond spreads on a backdrop of building supply supports the idea that MCDX spreads are likely to revert wider,” they wrote in a note published Friday.
