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Market Close: Tax-Exempts Steady in Quiet Monday

JUN 6, 2011 4:48pm ET
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Tax-exempt prices should stay elevated given how slim new issuance is, yet retail demand is unenthused about low rates.

Those forces caused a bit of stalemate Monday, as muni trading was quiet and yields were flat or slightly weaker from Friday’s levels.

“We need more bonds, we need liquidity,” a trader in Los Angeles said. “The phone is ringing with people saying 'show me something new,’ but I can’t manufacture bonds.”

Municipal Market Data’s triple-A scale hardly budged. Only yields in the 2016 to 2020 range moved at all, rising a single basis point.

The flat session left the 30-year muni yield at a calendar-year low of 4.25%, while the 10-year yield remained at 2.60%, just one basis point from its 2011 low in mid-May. The two-year yield held at 0.44%, also a calendar-year low.

“We know accounts have a great deal of cash on hand — money-manager and SMA-type accounts — and the reinvestment money in June and July is even compounding the issue,” said a trader in Florida. “But the bottom line is: they aren’t putting that money to work. There is no sense of urgency.”

MMD analyst Randy Smolik described the market as “sluggish,” noting short-intermediate yields were seeing a bit of flexibility as Treasury rates drifted higher.

A weekly survey from MMD found that traders have a neutral outlook for the direction of munis this week and this summer. The survey for the market’s direction this week found 100% of traders held a neutral outlook; for the coming one to two months, 72% were neutral and the rest were split between bulls and bears.

“Muni yields may very well be prodded one way or another in sympathy with significant Treasury moves, but it just does not seem likely that muni yields are going to break out of this general range in any meaningful way,” said Piper Jaffray’s team of tax-exempt analysts in a Monday note. They noted “the continued lack of new issue supply on one side, and the increasing apathy of muni investors at these historically low rates.”

If Treasuries are offering guidance, it’s for yields to drift higher. The benchmark 10-year yield rose two basis points from Friday’s close to 3.01%, the two-year yield was stable at 0.43%, and the 30-year yield climbed four basis points to 4.27%.

The 10-year muni-Treasury ratio was 86.96% Monday, while the 30-year ratio was 100.7%. Their long-term averages are 83.3% and 91.7%, respectively.

“The bottom line is: we’re back where we were last week,” the Florida trader added. “It sure seems like the market will turn sideways, or yields could even drift higher in sympathy with Treasuries.”

An upwardly revised calendar estimates new supply this week at $6.28 billion — the largest in 2011. Issuance year to date has averaged roughly $3.9 billion per week, or less than half of the 2010 average. Last week saw $3.39 billion enter the primary, according to revised estimates.

The larger offering this week might allow some weakness into the market, but price discovery will be limited as no major issues are on the calendar despite there being a half-dozen deals of more than $250 million.

“The secondary marketplace is a bit concerned that there are a few choices in the primary this week, but overall when you break it down a lot of the names are unique,” the Florida trader said. “They aren’t your general market, national trading names — like a state general obligation issue – to really give the marketplace some price discovery.”

In Monday’s market, Morgan Stanley priced for retail investors $189.8 million of refunding revenue bonds for the California Health Facilities Financing Authority. The two-pronged deal is rated Aa3 by Moody’s Investors Service and AA-minus by Fitch Ratings, and one notch lower by Standard & Poor’s. Yields range from 1.15% in 2012 to 5.30% in 2040.

The 2040 bonds are only available to institutional investors, who can begin buying Tuesday. A source at the underwriter said the institutional pricing could have been accelerated into Monday’s session if market conditions warranted it, but they didn’t.

Citi priced $99.2 million of hospital revenue bonds for the Tarrant County Cultural Education Facilities Finance Corp. Rated Aa2 by Moody’s and AA-minus by Standard & Poor’s, the bonds offer yields from 1.24% in 2012 to 5% in 2030.

George Friedlander, Citi’s chief muni strategist, made a list of several factors that should keep muni prices elevated going into summer. It includes diminished credit fears, support from cross-over buyers when muni-Treasury ratios get attractive, extremely light issuance, a heavy redemption period, and average portfolio maturities shrinking.

“We are not expecting muni yields to move sharply higher any time soon, unless new issues volume rebounds sharply,” Friedlander wrote in his weekly report.

If anything, rates could even fall further beyond calendar-year lows. Why? Friedlander sees the potential for deficit-reduction programs to reduce access to tax-exempt financing in 2012 and 2013, which would make outstanding tax-exempt paper more sought-after.

“This new potential 'risk’ strengthens the case for moving out along the yield curve when attractively priced paper can be found, including the purchase of high-quality zero coupon bonds,” he wrote.

A more astounding remark in Friedlander’s research was his claim that the Federal Reserve has “dramatically” understated the size and scope of the municipal bond market, by $775 billion.

The Fed reported that outstanding muni debt was $2.925 billion at year-end 2010, but Citi’s calculations, coupled with conversations with Fed officials, estimates the sum at roughly $3.7 trillion.

The understatement, Friedlander said, is caused by the Fed having no single source for calculating the household sector — which owns 38% of outstanding muni debt.

“We believe that the understatement is an old 'problem’ and that recent year-by-year net changes in bonds outstanding ... are fundamentally correct,” Friedlander wrote. “Early data underestimates, we believe, left the base number used in calculating estimates for bonds outstanding too low.”

It’s unclear if the Fed’s next estimate will incorporate any changes, but we’ll find out soon: it’s due for release Thursday, June 9.

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