Market Close: Munis Erase Early Week Losses To End Stronger

Despite losses earlier in the week, tax-exempts ended stronger Friday paring losses and then some as demand continues to outweigh supply.

Overall, the municipal bond market ended stronger for the week, pushing yields back down to near record lows.

Traders said new deals were received well and started to trade stronger in the secondary market Friday.

“New deals are breaking higher,” a New York trader said. ‘But it’s kind of quiet now.”

Others agreed activity had started to slow. “It’s pretty slow here,” a second New York trader said. “It seems like a good amount of bid wanteds out there but there is not much action on them. I am seeing some good action on trading releases on new issues, but I think that’s more mispricing than anything.”

He added in this continued period of low yields, the search for higher yielding products continues. “The stretch for yield trade is getting ridiculous. It will be a mess when it turns around and credit spreads go back to appropriate wides.”

Indeed, J.R. Rieger, vice president of fixed income at Standard & Poor’s Dow Jones Indices, noted that high yield municipal bonds have continued to post gains year-to-date. The S&P Municipal Bond High Yield Index has returned 14.63% year to date compared to the S&P Municipal Bond Investment Grade Index which returned 6.38% year-to-date.

“The yield spread between investment grade and high-yield municipal bonds has hovered around 321 basis points,” Rieger said.

And while the general high-yield market has performed well, Puerto Rico bonds have seen yields rise. The spread between the S&P Municipal Bond Puerto Rico Index and the S&P National AMT-Free Municipal Bond Index showed Puerto Rico bonds cheaper by 71 basis points at year end 2011, and that spread has widened to 127 basis points, Rieger said. “Further weakening can be a drag on state municipal bond funds with exposure to Puerto Rico.”

In terms of sectors, revenue bonds have outperformed general obligation bonds with the S&P Municipal Bond Revenue Index returning 7.98% while the S&P Municipal Bond General Obligation Index returned 5.62%.

Rieger added state GO bonds are still underperforming relative to locally issued GO bonds. State GOs have returned 4.88% year-to-date while local GOs have returned 6.63%.

On Friday, the Municipal Market Data scale showed firming. The 10-year yield fell one basis point to 1.69% while the 30-year yield dropped two basis points to 2.84%. The two-year yield finished flat at 0.30% for the 13th consecutive trading session.

Treasuries finished stronger Friday as well. The benchmark 10-year yield fell one basis point to 1.67% while the 30-year yield dropped two basis points to 2.84%. The two-year was steady at 0.27%.

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