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Market Close: Munis Weaker As Risk-On Trade Starts 2013

The tax-exempt market finished the first day of trading in 2013 on a weaker note as a late fiscal cliff deal pushed bond markets lower and equity markets higher.

After Congress passed the American Taxpayer Relief Act late Tuesday night, equity indexes soared Wednesday, putting selling pressure on bond markets.

The Dow Jones Industrial Average jumped 308 points, or 2.35%, to 13,412 while the Standard & Poor’s 500 Index spiked almost 37 points, or 2.54%, to 1,462. The Nasdaq rose over 92 points, or 3.07%, to 3,112.

And while Treasuries and many bond prices fell, muni yields were not following directly in line.

“I can’t say we are lockstep with Treasuries, but with the 30-year Treasury off, we are giving up a little ground,” a Dallas trader said. “But there are not even enough trades in the secondary market to tell what direction the market should be going.”

He added the Municipal Market Data scale is expected to set their forward roll for January maturities this afternoon, which is also providing some confusion on the value of bonds.

“It will probably take two to three days for the market to settle and new issues to get priced before everyone is comfortable,” the trader said. “So it’s very slow today overall.”

One New Jersey trader added that despite the Treasury selloff, munis were holding up fairly well.

John Hallacy, municipal research strategist at Bank of America Merrill Lynch agreed muni bond yields did not jump as high as Treasury yields.

“With equities up so much Treasury yields have backed off considerably,” Hallacy said. “One would think munis generally track Treasuries but we don’t have a lot of issuance this week so it’s a matter of people thinking about what the potentials are here.”

He added, “It’s a big rollover month with a lot of bonds coming due. So there is going to be a lot of fresh cash once again chasing supply. So that might create the odd environment where we are somewhat richer than other fixed-income markets, at least for the near term. Munis also came through the fiscal cliff process relatively unscathed so that will help.”

Hallacy added that sequestration has been delayed for two months and other spending cuts, including those that could affect municipalities, may be considered by Congress within that time.

“With the top rate at 39.6% that really stokes demand for munis, but the only caveat to that is when Congress comes back to look at cuts in two months,” Hallacy said. “Will there be anything that will touch munis? Just because tax policy has been set doesn’t mean they can’t come back and look at expenditures and muni interest exclusion is considered a tax expenditure. The major tax structure going forward has been set but there are always possibilities for refinement.”

With the passage of the American Taxpayer Relief Act, it is clear that the threat of taxing municipal bond interest is over — for now. But that threat will most likely return to markets when Congress discusses budget cuts expected to hit March 1.

Guy LeBas, fixed income strategist at Janney Capital Markets, said a 28% cap in muni tax exemption would effectively place an 11.6% tax on muni interest for top bracket investors. “Such a change would likely reprice the muni markets significantly lower, as it would reduce the value of tax exemption.”

“While there remains a potential for alternations to munis’ tax exemption as part of future tax reform, municipal interest remains fully tax-exempt with the passage of the ATRA,” LeBas noted. “Moreover, the increase in the highest tax bracket rates improves the value of that tax exemption in the short term, which should help the municipal markets outperform in the first few weeks of the year.”

In the secondary market Wednesday, trades compiled by data provider Markit showed slight weakening.

Yields on Connecticut 4s of 2030 jumped three basis points to 2.83% while Louisiana 5s of 2019 rose two basis points to 1.30%.

Yields on New York’s Metropolitan Transportation Authority 3s of 2028 and New York City Transitional Finance Authority 5s of 2035 increased one basis point each to 3.09% and 2.91%, respectively. Yields on Dallas Area Rapid Transit 3s of 2032 also rose one basis point to 3.20%.

On Wednesday, the Municipal Market Data scale finished slightly weaker, with yields rising one to two basis points across the curve. But after the MMD scale was adjusted for the January roll, yields were marked up between one and eight basis points.

Overall, the two-year MMD yield — now a 2015 maturity — rose five basis points to 0.36%. The 10-year MMD yield — now a 2023 maturity — finished six basis points higher at 1.78%. The 30-year MMD yield — now a 2043 maturity — closed three basis points higher at 2.86%.

Muni yields followed Treasury yields higher. The benchmark 10-year Treasury yield jumped eight basis points to 1.84% while the 30-year yield soared nine basis points to 3.04%. The two-year was steady at 0.26%.

Primary issuance in the muni bond market has been paltry over the past two weeks and isn’t expected to pick up any time soon. The Bond Buyer’s 30-day visible supply is up $204.4 million to a slim $4.187 billion. Competitive 30-day issuance is only $2.455 billion followed by $1.732 billion in the negotiated market.

The MuniCenter 30-day list topped $8 billion.

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