After almost a year of anticipation, the long-looming ominous cloud of a Federal Reserve taper finally broke on the municipal market last week. The ensuing storm has been but a whimper, said Bank of America's Phil Fischer.
In the fifth trading day since the Fed announced it would reduce its bond-buying program by $10 billion each month, beginning in January, municipal bonds have remained steady even as treasury yields climbed.
"Rates haven't exploded and I wouldn't expect municipals to have enough liquidity right now to stay with treasuries," Fischer, a municipal research strategist, said in an interview. "This is just the evolution of the taper scenario."
Traders and brokers interviewed since the Fed's decision agreed that municipals hadn't weakened to the point that many suspected they would before the start of a slowdown in quantitative easing.
"The muni market seems to be pretty resilient in the face of the treasury selloff this week," a trader in the southwest said in an interview. "It's actually looking better than I thought with a little more activity."
Yields on the Municipal Market Data triple-A scale Tuesday were mostly unchanged. Bonds maturing from 2019 to 2021 saw yields rise by a basis point. According to the Municipal Market Data triple-A scale, yields on bonds maturing from 21 years out weakened as much as a basis point.
Treasury yields surged from Friday. The benchmark 10-year yield climbed seven basis points to 2.99%, while the 30-year yield gained seven basis point to 3.90%.
The two-year yield rose one basis point to 0.40% after gaining six basis points last week.
"Compared to Treasuries, munis have been outperforming across the curve," the trader said. "The taper seems largely priced in, especially in the long end of the curve, where as the belly of the curve may have more selling off going forward."
Issuance was low during the holiday week, with potential volume about $15 million, down from total sales of $2.80 billion in the week ended Dec. 20.
The risk of rising rates will continue into the New Year resulting from a backup in Treasury rates, Fischer said in a Dec. 20 report. A steep muni yield curve will compensate investors for the risk, according to the report.
A durable goods orders report on Tuesday showed that manufacturing in the U.S. is regaining strength, with new factory orders in November gaining 3.5% after a 0.7% drop in October.
More reports of encouraging economic data such as the durable goods report could bring headwinds to muni investors in the early months of 2014, Fischer said, pointing out that the Fed could accelerate its tapering program.
"There won't be any issuance for a while so the technical in early January should be decent as we usually have a little bit of a rally then," Fischer said. "It's low liquidity and low issuance, which won't pick up until the middle of the year."
Fischer expects issuance in 2014 to be $330 billion, on par with issuance in 2013. That includes $160 billion of new money volume and $170 billion in total refunding volume.
The new money estimate marks a 6% increase from 2013, reflecting oncoming infrastructure needs as states and local governments in certain areas cope with growing populations.
Migration patterns of Americans are a vital element in understanding the future of the municipal bond market, Fischer said.
"Demographics are an overlay to your investing decision," Fischer said. "It shows where the bonds are going to come from, who is going to issue, and how they're going to behave."
According to a Dec. 13 report by BofA's municipal research team, Americans moving within the U.S. are leaving states from the northeast to those in western and southern regions. Californians, however, are also exiting their state.
The result for states like New York, Illinois and California, which have the highest net domestic outward migration, means a smaller tax base and an additional pressure on credit, Fischer said.
"New York and California are wealthy states that mostly can handle it, but it's not a positive thing for them," Fischer said. "It's also been a very touch recession for states that don't grow fast enough to overcome the demographic growth they face."
Texas, Florida and North Carolina, the states with the largest number of incoming migrants, will benefit from rising local tax revenues and are more likely to build out their infrastructure, the report said.
"That's where you're going to see more municipal projects, " Fischer said. "Also with an increase of more tax revenues, the credit issues pressuring some parts of the country are likely to abate soon."
The net aggregated adjusted gross income loss from migrants moving out of California between 2000 and 2010 was $29.4 billion in 2010 dollars, according to data from the Internal Revenue Service's Tax Foundation. New York lost $45.6 billion of income.
Florida gained $67.3 billion in adjusted gross income of migrants coming into the state, while Texas gained $17.6 billion in 2010.
Trades in the secondary market were scarce on Tuesday, according to data from Markit after bonds were mixed Monday.
Nevada higher education university revenue bonds with a 4% coupon maturing in 2019 saw yields rise four basis points Monday to 1.88%, and University of Connecticut general obligation bonds with a 5% coupon maturing in 2031 climbed two basis points to 4.12%.
Philadelphia Hospitals and Higher Education Facilities revenue bonds with a 5.625% coupon maturing in 2036 slid three basis points Monday to 7.05%.
