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Market Post: After Choppy Week, Munis Head Lower

NEW YORK - The tax-exempt market appeared to end a whipsaw week, with munis strengthening some days, and weakening on others. Still, there were no dramatic changes in yields and traders noted the market may have only shifted a few basis points.

"At the end of the day we did OK," a Chicago trader said. "It was like playing ping pong over one basis point. It was back and forth."

Munis were steady to slightly weaker Friday afternoon, according to the Municipal Market Data scale. Yields inside 14 years were steady while yields outside 15 years rose one basis point.

On Thursday, the 10-year tax-exempt yield closed at 1.86% for the fifth consecutive trading session while the two-year yield finished flat at 0.32% for the 15th straight session. The 30-year yield fell two basis points to 3.15%.

Treasuries continued to weaken in the afternoon session, erasing all gains made Thursday. The benchmark 10-year yield jumped five basis points to 1.67% while the 30-year yield spiked up seven basis points to 2.75%. The two-year was steady at 0.31%.

So far this week, muni-to-Treasury ratios have fallen as munis outperformed Treasuries and became relatively more expensive.

The two-year ratio dropped to 103.2% on Thursday from 106.7% on Monday. The 10-year ratio fell to 114.8% on Thursday from 117.7%. The 30-year ratio dropped slightly to 117.5% from 118% at the beginning of the week.

With volatility and economic uncertainty coming from Europe, investors continue to rush into safe-haven assets, compressing spreads on municipal bonds. Investors have been forced to reach down the credit scale in search for yield.

Yields on investment grade municipal bonds as measured by the S&P National AMT-Free Municipal Bond Index have fallen one basis point in June and have returned 1.82% this quarter and 3.61% year to date, according to J.R. Rieger, vice president of fixed income indexes at Standard & Poor's Indices.

On the other hand, yields on high-yield municipal bonds have fallen four basis points since the start of June and 88 basis points since the beginning of the year. As a result, Rieger said high-yield munis, as measured by the S&P Municipal High Yield Index, returned 3.5% this quarter and 9.77% year to date, outperforming the stock market and the overall bond market.

Over the course of the previous 12 months since June 30, 2011, the S&P high-yield index returned 15.39%, while the investment-grade index returned 10.04%. Conversely, the S&P 500 Index returned 2.56%.

Indeed, some of the best performers have been higher-yielding states. Performance of all credit qualities of bonds issued in California returned 4.70% year to date, followed by New Jersey at 4.51%. Bonds of all qualities issued in Florida returned 4.15% while bonds in Arizona yielded 4.01%. Puerto Rico rounded out the top five, returning 3.96%.

Year to date, some of the poorest performers have been the higher-quality states, including Georgia which returned 2.70% and Utah which returned 2.40%.

In next week's primary market, $8.11 billion in municipal bonds are expected to be priced, down from this week's revised $9.03 billion. In negotiated deals, $6.49 billion is expected, down from this week's revised $7 billion. On the competitive calendar, $1.62 billion is expected to be auctioned, down from this week's revised $2.03 billion.

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